Be cautious of exceptional gains

All that shines isn't necessarily gold, and not all declared profits stem from actual business success. Exceptional gains, i.e., one-time boosts to a company's earnings, can often inflate profitability numbers and lead to false narratives. For example, let's consider a bakery chain named ABC. It made a profit after tax of Rs 50 lakh in 2021. In 2022, however, it made a profit after tax of Rs 75 lakh, a whopping 50 per cent year-on-year jump. So, going by the numbers, one would assume that ABC bakery's cakes are selling like, well, hot cakes. However, ABC had been struggling with demand. In fact, it had to sell off multiple outlets for Rs 80 lakh in 2022. The money it received, as per accounting norms, was booked as profit. So, if you take this one-time gain out, the bakery actually incurred losses in 2022! To find businesses similar to ABC, i.e., whose profits have been inflated by one-time gains, we conducted an exercise. We applied the following filters on BSE companies (non-BFSI) with a market cap larger than Rs 1,000 crore. Five-year (FY19-23) cumulative profit before tax >0 Five-year cumulative adjusted (for exceptional items) profit before tax 0 An exceptional mirage The cumulative profits of these companies turned into losses when exceptional items were removed. Company M-cap (Rs cr) Cumulative PBT(FY19-23; Rs cr) Cumulative exceptional items(FY19-23; Rs cr) Adjusted PBT(FY19-23; Rs cr) GE T&D India 8443 26 49 -23 The India Cements 7555 92 172 -81 MMTC 6362 120 331 -211 Tilaknagar Industries 4045

This article was originally published on September 04, 2023.