Zeal Global Services (NSE:ZEAL) Strong Profits May Be Masking Some Underlying Issues

The stock price didn't jump after Zeal Global Services Limited (NSE:ZEAL) posted decent earnings last week. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

See our latest analysis for Zeal Global Services

A Closer Look At Zeal Global Services' 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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Zeal Global Services has an accrual ratio of 0.53 for the year to September 2023. 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 ₹100.9m, a look at free cash flow indicates it actually burnt through ₹62m in the last year. We also note that Zeal Global Services' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹62m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zeal Global Services.

Our Take On Zeal Global Services' Profit Performance

As we have made quite clear, we're a bit worried that Zeal Global Services didn't back up the last year's profit with free cashflow. For this reason, we think that Zeal Global 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To help with this, we've discovered 3 warning signs (2 can't be ignored!) that you ought to be aware of before buying any shares in Zeal Global Services.

This note has only looked at a single factor that sheds light on the nature of Zeal Global Services' 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.