Kody Technolab's (NSE:KODYTECH) Profits May Not Reveal Underlying Issues

Following the solid earnings report from Kody Technolab Limited (NSE:KODYTECH), the market responded by bidding up the stock price. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

See our latest analysis for Kody Technolab

A Closer Look At Kody Technolab's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Kody Technolab has an accrual ratio of 1.15 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of ₹142.9m, a look at free cash flow indicates it actually burnt through ₹360m in the last year. We also note that Kody Technolab's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹360m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kody Technolab.

Our Take On Kody Technolab's Profit Performance

As we have made quite clear, we're a bit worried that Kody Technolab didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Kody Technolab's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example - Kody Technolab has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Kody Technolab's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.