3R Petroleum Óleo e Gás (BVMF:RRRP3) Shareholders Should Be Cautious Despite Solid Earnings

Following the release of a positive earnings report recently, 3R Petroleum Óleo e Gás S.A.'s (BVMF:RRRP3) stock performed well. However, we think that investors should be cautious when interpreting the profit numbers.

View our latest analysis for 3R Petroleum Óleo e Gás

Zooming In On 3R Petroleum Óleo e Gás' 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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 December 2023, 3R Petroleum Óleo e Gás had an accrual ratio of 0.63. 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. Even though it reported a profit of R$405.2m, a look at free cash flow indicates it actually burnt through R$5.1b in the last year. We also note that 3R Petroleum Óleo e Gás' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of R$5.1b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. 3R Petroleum Óleo e Gás expanded the number of shares on issue by 18% over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out 3R Petroleum Óleo e Gás' historical EPS growth by clicking on this link.

A Look At The Impact Of 3R Petroleum Óleo e Gás' Dilution On Its Earnings Per Share (EPS)

Three years ago, 3R Petroleum Óleo e Gás lost money. On the bright side, in the last twelve months it grew profit by 171%. But EPS was less impressive, up only 145% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So 3R Petroleum Óleo e Gás shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On 3R Petroleum Óleo e Gás' Profit Performance

As it turns out, 3R Petroleum Óleo e Gás couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue 3R Petroleum Óleo e Gás' profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 3 warning signs for 3R Petroleum Óleo e Gás (of which 2 make us uncomfortable!) 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. 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.