We Believe Aya Gold & Silver's (TSE:AYA) Earnings Are A Poor Guide For Its Profitability

Strong earnings weren't enough to please Aya Gold & Silver Inc.'s (TSE:AYA) shareholders over the last week. Our analysis found several concerning factors in the earnings report beyond the strong statutory profit number.

See our latest analysis for Aya Gold & Silver

A Closer Look At Aya Gold & Silver's 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. 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. 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 2023, Aya Gold & Silver had an accrual ratio of 0.69. 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 US$106m despite its profit of US$5.50m, mentioned above. We also note that Aya Gold & Silver's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$106m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Aya Gold & Silver increased the number of shares on issue by 12% over the last twelve months by issuing new shares. 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. Check out Aya Gold & Silver's historical EPS growth by clicking on this link.

How Is Dilution Impacting Aya Gold & Silver's Earnings Per Share (EPS)?

Aya Gold & Silver was losing money three years ago. On the bright side, in the last twelve months it grew profit by 1,081%. But EPS was less impressive, up only 954% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So Aya Gold & Silver 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 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 Aya Gold & Silver's Profit Performance

In conclusion, Aya Gold & Silver 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. Considering all this we'd argue Aya Gold & Silver's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Aya Gold & Silver is showing 2 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

Our examination of Aya Gold & Silver 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 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.