Dreamfolks Services' (NSE:DREAMFOLKS) Profits Appear To Have Quality Issues

Dreamfolks Services Limited's (NSE:DREAMFOLKS) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for Dreamfolks Services

Examining Cashflow Against Dreamfolks Services' 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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 September 2023, Dreamfolks Services recorded an accrual ratio of 0.70. 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. Over the last year it actually had negative free cash flow of ₹56m, in contrast to the aforementioned profit of ₹751.4m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹56m, this year, indicates high risk.

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.

Our Take On Dreamfolks Services' Profit Performance

As we discussed above, we think Dreamfolks Services' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Dreamfolks Services' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Dreamfolks Services as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for Dreamfolks Services you should be mindful of and 1 of these is a bit unpleasant.

This note has only looked at a single factor that sheds light on the nature of Dreamfolks Services' profit. But there are plenty of other ways to inform your opinion of a company. 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.