In 2022, I watched a stock rally from ₹180 to ₹220 on the back of “strong earnings growth.”
Quarterly results looked perfect:
– Revenue up 28% YoY
– PAT up 35% YoY
– Margins expanding
– Analysts upgrading targets to ₹320
Twelve months later, the stock was at ₹95. The auditor had flagged receivables issues, the CFO had resigned, and the company was scrambling to explain “working capital stress.”
What did I see that the market missed?
One line buried in the Cash Flow Statement told me everything I needed to know—nine months before it became obvious to everyone else.
That line: Operating Cash Flow (OCF).
Let me show you exactly what I look for, because this single check has saved me from more bad investments than any PE ratio or revenue growth number ever has.
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The Pattern That Repeats Every Time
Most investors read quarterly results like this:
- Revenue growing? Good.
- PAT growing? Great.
- Stock going up? Buy more.
But here’s what they miss:
Profit can be manufactured. Cash flow can’t.
When a company reports strong profits but weak (or negative) cash flow for multiple quarters, one of three things is happening:
- Revenue is being booked before customers actually pay (aggressive accounting)
- Inventory is piling up (channel stuffing—pushing products into distribution that aren’t selling through)
- Debtors are exploding (selling to anyone who’ll sign a paper, regardless of ability to pay)
All three end the same way: Provisions, write-offs, auditor red flags, and stock price collapse.
The Formula I Use (Takes 2 Minutes)
OCF Conversion Rate = (Operating Cash Flow ÷ Net Profit) × 100
Here’s how to interpret it:
- >80%: Healthy. Profit is converting to cash.
- 50-80%: Yellow flag. Watch closely.
- <50%: Red flag. Profit quality is poor.
- Negative OCF with growing PAT: Run. Don’t walk.
Where to Find This (In 2 Minutes)
Step 1: Open the company’s quarterly results PDF
Step 2: Go to the Cash Flow Statement (usually page 3-4)
Step 3: Find “Cash Flow from Operating Activities”
Step 4: Compare to Net Profit from the P&L Statement
If OCF is consistently <70% of PAT for three or more consecutive quarters, probe deeper.
Ask yourself:
- Why is profit not converting to cash?
- Are debtors increasing faster than revenue?
- Is inventory building up?
- Is the company giving longer credit to push sales?
If you can’t find a satisfactory explanation in management commentary, it’s a red flag.
Why This Works
Accounting standards give management a lot of flexibility in when they recognize revenue.
But cash? Cash is binary. Either it’s in the bank or it isn’t.
When profit and cash flow diverge for extended periods, always trust the cash.
I’ve seen this pattern play out at least a dozen times over the past decade:
- Strong reported profits
- Weak/negative operating cash flow
- Stock rallies initially
- 6-12 months later: Reality catches up
- Stock crashes 40-60%
The investors who check cash flow see it coming. The ones who only look at PAT get caught.
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Disclaimer: This is not a recommendation to buy/sell any of the stocks mentioned above. The securities quoted are for illustration only and are not recommendatory.
Ekansh Mittal
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