The Strong Earnings Posted By Olympic Circuit Technology (SHSE:603920) Are A Good Indication Of The Strength Of The Business

Olympic Circuit Technology Co., Ltd (SHSE:603920) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Check out our latest analysis for Olympic Circuit Technology

Examining Cashflow Against Olympic Circuit Technology's 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2023, Olympic Circuit Technology recorded an accrual ratio of -0.24. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥1.2b, well over the CN¥495.5m it reported in profit. Notably, Olympic Circuit Technology had negative free cash flow last year, so the CN¥1.2b it produced this year was a welcome improvement. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Olympic Circuit Technology expanded the number of shares on issue by 24% over the last year. Therefore, each share now receives a smaller portion of profit. 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 Olympic Circuit Technology's historical EPS growth by clicking on this link.

A Look At The Impact Of Olympic Circuit Technology's Dilution On Its Earnings Per Share (EPS)

Olympic Circuit Technology has improved its profit over the last three years, with an annualized gain of 63% in that time. And over the last 12 months, the company grew its profit by 14%. On the other hand, earnings per share are only up 14% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Olympic Circuit Technology 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 Olympic Circuit Technology's Profit Performance

At the end of the day, Olympic Circuit Technology is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Based on these factors, we think that Olympic Circuit Technology's profits are a reasonably conservative guide to its underlying profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. You'd be interested to know, that we found 2 warning signs for Olympic Circuit Technology and you'll want to know about these.

Our examination of Olympic Circuit Technology has focussed on certain factors that can make its earnings look better than they are. 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 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.