Shareholders In Locality Planning Energy Holdings (ASX:LPE) Should Look Beyond Earnings For The Full Story

Despite posting strong earnings, Locality Planning Energy Holdings Limited's (ASX:LPE) stock didn't move much over the last week. We decided to have a deeper look, and we believe that investors might be worried about several concerning factors that we found.

View our latest analysis for Locality Planning Energy Holdings

Zooming In On Locality Planning Energy Holdings' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to June 2022, Locality Planning Energy Holdings had an accrual ratio of 0.86. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of AU$12m despite its profit of AU$6.13m, mentioned above. We also note that Locality Planning Energy Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of AU$12m. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Locality Planning Energy Holdings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Locality Planning Energy Holdings expanded the number of shares on issue by 118% 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. You can see a chart of Locality Planning Energy Holdings' EPS by clicking here.

A Look At The Impact Of Locality Planning Energy Holdings' Dilution On Its Earnings Per Share (EPS)

Locality Planning Energy Holdings was losing money three years ago. The good news is that profit was up 568% in the last twelve months. On the other hand, earnings per share are only up 283% over the same period. So you can see that the dilution has had a fairly significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Locality Planning Energy Holdings 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 Locality Planning Energy Holdings' Profit Performance

In conclusion, Locality Planning Energy Holdings has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. On reflection, the above-mentioned factors give us the strong impression that Locality Planning Energy Holdings'underlying earnings power is not as good as it might seem, based on the statutory profit numbers. So while earnings quality is important, it's equally important to consider the risks facing Locality Planning Energy Holdings at this point in time. Every company has risks, and we've spotted 4 warning signs for Locality Planning Energy Holdings you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.