There May Be Underlying Issues With The Quality Of Genus Power Infrastructures' (NSE:GENUSPOWER) Earnings

Investors were disappointed with Genus Power Infrastructures Limited's (NSE:GENUSPOWER) earnings, despite the strong profit numbers. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for Genus Power Infrastructures

Examining Cashflow Against Genus Power Infrastructures' 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). 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2024, Genus Power Infrastructures recorded an accrual ratio of 0.28. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of ₹2.3b, in contrast to the aforementioned profit of ₹866.7m. It's worth noting that Genus Power Infrastructures generated positive FCF of ₹618m a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. One positive for Genus Power Infrastructures shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Genus Power Infrastructures increased the number of shares on issue by 20% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Genus Power Infrastructures' EPS by clicking here.

How Is Dilution Impacting Genus Power Infrastructures' Earnings Per Share (EPS)?

As you can see above, Genus Power Infrastructures has been growing its net income over the last few years, with an annualized gain of 26% over three years. And at a glance the 199% gain in profit over the last year impresses. But in comparison, EPS only increased by 187% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Genus Power Infrastructures can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Genus Power Infrastructures' Profit Performance

In conclusion, Genus Power Infrastructures has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at Genus Power Infrastructures' statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Genus Power Infrastructures has 2 warning signs (and 1 which is concerning) we think you should know about.

Our examination of Genus Power Infrastructures has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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 with significant insider holdings 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.