Widely read:
हिंदी में भी पढ़ें 
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 | 264 | 546 | -282 |
| Pricol | 3962 | 0.3 | 10 | -9 |
| Ramky Infrastructure | 3790 | 1182 | 1294 | -112 |
| Raj Rayon Industries | 2478 | 511 | 671 | -160 |
| ISMT | 2360 | 1844 | 2430 | -586 |
| Oriental Hotels | 1542 | 80 | 95 | -15 |
| Shriram Properties | 1541 | 107 | 121 | -14 |
| Orient Green Power | 1366 | 2 | 62 | -59 |
| Rane (Madras) | 1060 | 10 | 33 | -23 |
| M-cap as of August 29, 2023. PBT refers to profit before tax. | ||||
All of the companies actually lost money in the last five years. However, their exceptional gains helped them save face and keep their earnings in the green.
Your takeaway
The above exercise highlights the importance of scrutinising the book before investing. It is not enough to vaguely check if the company has remained profitable. It is also equally important to verify where the earnings are originating from.
Note while we used the selling of assets as a one-time gain, it is not the only exceptional gain you should look out for. Tilaknagar Industries , Ramky Infra , Raj Rayon Industries and ISMT , four companies on our list, reported exceptional gains from debt restructuring.
In short, if a huge chunk of a company's earnings is coming from sources other than the core business, you should exercise caution.
Also read: The electrifying run of wire and cable manufacturers
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