Blockchain Foundry's (CSE:BCFN) Robust Profit May Be Overstating Its True Earnings Potential

Shareholders didn't seem to be thrilled with Blockchain Foundry Inc.'s (CSE:BCFN) recent earnings report, despite healthy profit numbers. Our analysis has found some concerning factors which weaken the profit's foundation.

See our latest analysis for Blockchain Foundry

Zooming In On Blockchain Foundry's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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 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. 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 2021, Blockchain Foundry had an accrual ratio of 1.34. Statistically speaking, that's a real negative for future earnings. 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 CA$2.2m despite its profit of CA$3.80m, mentioned above. We also note that Blockchain Foundry's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CA$2.2m. 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 Blockchain Foundry.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Blockchain Foundry increased the number of shares on issue by 39% over the last twelve months by issuing new shares. As a result, its net income is now split between 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. Check out Blockchain Foundry's historical EPS growth by clicking on this link.

A Look At The Impact Of Blockchain Foundry's Dilution on Its Earnings Per Share (EPS).

Three years ago, Blockchain Foundry lost money. On the bright side, in the last twelve months it grew profit by 4,113%. On the other hand, earnings per share are only up 2,838% over the same period. So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Blockchain Foundry 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 Blockchain Foundry's Profit Performance

As it turns out, Blockchain Foundry 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 Blockchain Foundry'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 Blockchain Foundry is showing 5 warning signs in our investment analysis and 2 of those are potentially serious...

Our examination of Blockchain Foundry 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 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. 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.