NTG Clarity Networks' (CVE:NCI) Earnings Might Be Weaker Than You Think

Shareholders were pleased with the recent earnings report from NTG Clarity Networks Inc. (CVE:NCI). However, we think that investors should be cautious when interpreting the profit numbers.

View our latest analysis for NTG Clarity Networks

A Closer Look At NTG Clarity Networks' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

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".

Over the twelve months to June 2024, NTG Clarity Networks recorded an accrual ratio of 0.74. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of CA$17k during the period, falling well short of its reported profit of CA$4.25m. NTG Clarity Networks shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. 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 NTG Clarity Networks.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. NTG Clarity Networks expanded the number of shares on issue by 27% over the last year. As a result, its net income is now split between 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 NTG Clarity Networks' EPS by clicking here.

How Is Dilution Impacting NTG Clarity Networks' Earnings Per Share (EPS)?

NTG Clarity Networks has improved its profit over the last three years, with an annualized gain of 685% in that time. In comparison, earnings per share only gained 290% over the same period. And the 65% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 19% over the same period. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if NTG Clarity Networks can grow EPS persistently. 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.

Our Take On NTG Clarity Networks' Profit Performance

In conclusion, NTG Clarity Networks 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. For the reasons mentioned above, we think that a perfunctory glance at NTG Clarity Networks' statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about NTG Clarity Networks as a business, it's important to be aware of any risks it's facing. When we did our research, we found 5 warning signs for NTG Clarity Networks (2 are a bit concerning!) that we believe deserve your full attention.

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. 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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com