North Eastern Carrying's (NSE:NECCLTD) Earnings Are Weaker Than They Seem

Unsurprisingly, North Eastern Carrying Corporation Limited's (NSE:NECCLTD) stock price was strong on the back of its healthy earnings report. However, we think that shareholders may be missing some concerning details in the numbers.

Check out our latest analysis for North Eastern Carrying

Zooming In On North Eastern Carrying's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2024, North Eastern Carrying recorded an accrual ratio of 0.21. 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 ₹456m, in contrast to the aforementioned profit of ₹119.3m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹456m, this year, indicates high risk. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of North Eastern Carrying.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, North Eastern Carrying issued 6.9% more new shares over the last year. 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. Check out North Eastern Carrying's historical EPS growth by clicking on this link.

A Look At The Impact Of North Eastern Carrying's Dilution On Its Earnings Per Share (EPS)

North Eastern Carrying has improved its profit over the last three years, with an annualized gain of 111% in that time. But on the other hand, earnings per share actually fell by 0.5% per year. And the 102% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 15% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So North Eastern Carrying shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On North Eastern Carrying's Profit Performance

In conclusion, North Eastern Carrying 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. Considering all this we'd argue North Eastern Carrying's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 3 warning signs for North Eastern Carrying (1 can't be ignored) you should be familiar with.

Our examination of North Eastern Carrying 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. 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 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.