Entersoft (ATH:ENTER) Is Growing Earnings But Are They A Good Guide?

As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Entersoft's (ATH:ENTER) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Entersoft made a profit of €2.87m on revenue of €15.4m. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Entersoft

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Entersoft's cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Entersoft.

A Closer Look At Entersoft'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Over the twelve months to June 2020, Entersoft recorded an accrual ratio of -0.11. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of €3.7m, well over the €2.87m it reported in profit. Entersoft shareholders are no doubt pleased that free cash flow improved over the last twelve months. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Entersoft expanded the number of shares on issue by 12% 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. Check out Entersoft's historical EPS growth by clicking on this link.

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

Entersoft has improved its profit over the last three years, with an annualized gain of 125% in that time. And at a glance the 61% gain in profit over the last year impresses. On the other hand, earnings per share are only up 55% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Entersoft can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Entersoft's Profit Performance

At the end of the day, Entersoft 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. Given the contrasting considerations, we don't have a strong view as to whether Entersoft's profits are an apt reflection of its underlying potential for profit. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. You'd be interested to know, that we found 3 warning signs for Entersoft and you'll want to know about them.

Our examination of Entersoft 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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