Earnings Quality

Earnings quality refers to the degree to which a company's reported net profit accurately reflects its true, sustainable economic performance — as opposed to being inflated by one-time items, aggressive accounting choices, or non-cash adjustments. High-quality earnings are characterised by strong conversion into operating cash flow (a cash conversion ratio close to 1 or above), recurring and predictable sources, conservative revenue recognition, and minimal reliance on non-operating income. Low-quality earnings may feature large divergences between reported profit and operating cash flow, frequent one-time gains or write-backs, or accelerated revenue recognition. For Indian equity investors, assessing earnings quality requires comparing net profit against operating cash flow, scrutinising notes to accounts, and looking for consistency in accounting policies across financial years.