Harris Technology Group Limited's (ASX:HT8) stock performed strongly after the recent earnings report. Despite this, we feel that there are some reasons to be cautious with these earnings.
Examining Cashflow Against Harris Technology Group's Earnings
Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to June 2021, Harris Technology Group recorded an accrual ratio of 1.60. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of AU$4.0m despite its profit of AU$1.75m, mentioned above. We also note that Harris Technology Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of AU$4.0m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Harris Technology Group.
To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Harris Technology Group expanded the number of shares on issue by 26% over the last year. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Harris Technology Group's historical EPS growth by clicking on this link.
A Look At The Impact Of Harris Technology Group's Dilution on Its Earnings Per Share (EPS).
Harris Technology Group was losing money three years ago. The good news is that profit was up 74% in the last twelve months. But EPS was less impressive, up only 34% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.
In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Harris Technology Group can grow EPS persistently. 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.
Our Take On Harris Technology Group's Profit Performance
As it turns out, Harris Technology Group couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at Harris Technology Group's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Harris Technology Group, you'd also look into what risks it is currently facing. To that end, you should learn about the 4 warning signs we've spotted with Harris Technology Group (including 1 which is potentially serious).
Our examination of Harris Technology Group 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. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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