Solid Earnings Reflect Novabase S.G.P.S' (FRA:NVQ) Strength As A Business

The subdued stock price reaction suggests that Novabase S.G.P.S., S.A.'s (FRA:NVQ) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for Novabase S.G.P.S

Examining Cashflow Against Novabase S.G.P.S' 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. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to June 2024, Novabase S.G.P.S had an accrual ratio of -0.21. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of €9.9m, well over the €3.39m it reported in profit. Novabase S.G.P.S' free cash flow improved over the last year, which is generally good to see. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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 Novabase S.G.P.S.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Novabase S.G.P.S issued 44% more new shares over the last year. 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. You can see a chart of Novabase S.G.P.S' EPS by clicking here.

How Is Dilution Impacting Novabase S.G.P.S' Earnings Per Share (EPS)?

Unfortunately, Novabase S.G.P.S' profit is down 26% per year over three years. The good news is that profit was up 167% in the last twelve months. On the other hand, earnings per share are only up 166% over the same period. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Novabase S.G.P.S 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.

Our Take On Novabase S.G.P.S' Profit Performance

At the end of the day, Novabase S.G.P.S 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, it's hard to tell if Novabase S.G.P.S' profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into Novabase S.G.P.S, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Novabase S.G.P.S (2 are a bit concerning!) that we believe deserve your full attention.

Our examination of Novabase S.G.P.S has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.