Cipher Pharmaceuticals' (TSE:CPH) Anemic Earnings Might Be Worse Than You Think

Cipher Pharmaceuticals Inc.'s (TSE:CPH) earnings announcement last week contained some soft numbers, disappointing investors. We did some digging and think there are some comforting factors lying beneath the statutory profit numbers.

See our latest analysis for Cipher Pharmaceuticals

Examining Cashflow Against Cipher Pharmaceuticals' 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. 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. 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. 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".

Cipher Pharmaceuticals has an accrual ratio of 1.01 for the year to September 2024. 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. Even though it reported a profit of US$15.9m, a look at free cash flow indicates it actually burnt through US$67m in the last year. It's worth noting that Cipher Pharmaceuticals generated positive FCF of US$15m a year ago, so at least they've done it in the past. 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. Cipher Pharmaceuticals expanded the number of shares on issue by 6.5% over the last year. That means its earnings are split among a greater number of shares. 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. You can see a chart of Cipher Pharmaceuticals' EPS by clicking here.

A Look At The Impact Of Cipher Pharmaceuticals' Dilution On Its Earnings Per Share (EPS)

As you can see above, Cipher Pharmaceuticals has been growing its net income over the last few years, with an annualized gain of 227% over three years. Net income was down 51% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 49%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Cipher Pharmaceuticals' EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Cipher Pharmaceuticals saw its profit reduced by unusual items worth US$1.9m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Cipher Pharmaceuticals to produce a higher profit next year, all else being equal.

Our Take On Cipher Pharmaceuticals' Profit Performance

In conclusion, Cipher Pharmaceuticals' accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. On top of that, the dilution means that shareholders now own less of the company. Based on these factors, we think that Cipher Pharmaceuticals' statutory profits probably make it seem better than it is on an underlying level. If you want to do dive deeper into Cipher Pharmaceuticals, you'd also look into what risks it is currently facing. To that end, you should learn about the 3 warning signs we've spotted with Cipher Pharmaceuticals (including 1 which is a bit concerning).

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 with significant insider holdings 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.