Is There More To The Story Than Dicker Data's (ASX:DDR) Earnings Growth?

As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Dicker Data (ASX:DDR).

We like the fact that Dicker Data made a profit of AU$54.3m on its revenue of AU$1.76b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Dicker Data

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So this article aims to better understand Dicker Data's underlying earnings power by taking a look at how dilution, and unusual items are impacting it, and considering how well those paper profits are being converted into cash flow. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dicker Data.

A Closer Look At Dicker Data's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2019, Dicker Data had an accrual ratio of 0.28. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Indeed, in the last twelve months it reported free cash flow of AU$638k, which is significantly less than its profit of AU$54.3m. Dicker Data shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Dicker Data expanded the number of shares on issue by 6.6% over the last year. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Dicker Data's EPS by clicking here.

A Look At The Impact Of Dicker Data's Dilution on Its Earnings Per Share (EPS).

As you can see above, Dicker Data has been growing its net income over the last few years, with an annualized gain of 112% over three years. And the 67% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 67% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Dicker Data shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Dicker Data's profit was boosted by unusual items worth AU$12m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Dicker Data's Profit Performance

In conclusion, Dicker Data's weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For the reasons mentioned above, we think that a perfunctory glance at Dicker Data's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Dicker Data at this point in time. For example, Dicker Data has 5 warning signs (and 2 which are significant) we think you should know about.

Our examination of Dicker Data has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.
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