Cambridge Technology Enterprises' (NSE:CTE) Earnings Are Weaker Than They Seem

Unsurprisingly, Cambridge Technology Enterprises Limited's (NSE:CTE) stock price was strong on the back of its healthy earnings report. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out our latest analysis for Cambridge Technology Enterprises

Examining Cashflow Against Cambridge Technology Enterprises' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Cambridge Technology Enterprises has an accrual ratio of 0.43 for the year to March 2022. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of ₹194m despite its profit of ₹98.0m, mentioned above. It's worth noting that Cambridge Technology Enterprises generated positive FCF of ₹85m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Cambridge Technology Enterprises.

Our Take On Cambridge Technology Enterprises' Profit Performance

As we discussed above, we think Cambridge Technology Enterprises' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Cambridge Technology Enterprises' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 11% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Cambridge Technology Enterprises at this point in time. For example, Cambridge Technology Enterprises has 3 warning signs (and 2 which are concerning) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Cambridge Technology Enterprises' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.