Additional Considerations Required While Assessing KPI Green Energy's (NSE:KPIGREEN) Strong Earnings

Despite posting some strong earnings, the market for KPI Green Energy Limited's (NSE:KPIGREEN) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for KPI Green Energy

A Closer Look At KPI Green Energy's 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. 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.

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.

For the year to September 2023, KPI Green Energy had an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of ₹1.2b, in contrast to the aforementioned profit of ₹1.34b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹1.2b, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of KPI Green Energy.

Our Take On KPI Green Energy's Profit Performance

As we have made quite clear, we're a bit worried that KPI Green Energy didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that KPI Green Energy'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. 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 KPI Green Energy as a business, it's important to be aware of any risks it's facing. Be aware that KPI Green Energy is showing 4 warning signs in our investment analysis and 1 of those doesn't sit too well with us...

This note has only looked at a single factor that sheds light on the nature of KPI Green Energy's 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.