Despite posting strong earnings, GoGold Resources Inc.'s (TSE:GGD) stock didn't move much over the last week. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.
Examining Cashflow Against GoGold Resources' 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. 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. 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.
For the year to December 2020, GoGold Resources had an accrual ratio of 0.50. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of US$46.9m, a look at free cash flow indicates it actually burnt through US$833k in the last year. We also note that GoGold Resources' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$833k. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.
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. GoGold Resources expanded the number of shares on issue by 43% 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. Check out GoGold Resources' historical EPS growth by clicking on this link.
How Is Dilution Impacting GoGold Resources' Earnings Per Share? (EPS)
GoGold Resources was losing money three years ago. On the bright side, in the last twelve months it grew profit by 10,374%. But EPS was less impressive, up only 7,978% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.
Changes in the share price do tend to reflect changes in earnings per share, in the long run. So GoGold Resources 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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.
The Impact Of Unusual Items On Profit
The fact that the company had unusual items boosting profit by US$5.9m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If GoGold Resources doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.
Our Take On GoGold Resources' Profit Performance
GoGold Resources didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. On reflection, the above-mentioned factors give us the strong impression that GoGold Resources'underlying earnings power is not as good as it might seem, based on the statutory profit numbers. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To that end, you should learn about the 4 warning signs we've spotted with GoGold Resources (including 2 which don't sit too well with us).
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 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. 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. 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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