Flat Glass Group's (HKG:6865) Profits May Not Reveal Underlying Issues

Flat Glass Group Co., Ltd.'s (HKG:6865) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Flat Glass Group

Examining Cashflow Against Flat Glass Group's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Over the twelve months to December 2023, Flat Glass Group recorded an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥2.76b, a look at free cash flow indicates it actually burnt through CN¥3.6b in the last year. We also note that Flat Glass Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥3.6b. 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Flat Glass Group expanded the number of shares on issue by 9.2% over the last year. That means its earnings are split among 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 Flat Glass Group's historical EPS growth by clicking on this link.

How Is Dilution Impacting Flat Glass Group's Earnings Per Share (EPS)?

Flat Glass Group has improved its profit over the last three years, with an annualized gain of 69% in that time. In comparison, earnings per share only gained 49% over the same period. And the 30% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 25% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Flat Glass Group can grow EPS persistently. 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 Flat Glass Group's Profit Performance

In conclusion, Flat Glass Group 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 Flat Glass Group's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Flat Glass Group as a business, it's important to be aware of any risks it's facing. For example, we've found that Flat Glass Group has 4 warning signs (1 can't be ignored!) that deserve your attention before going any further with your analysis.

Our examination of Flat Glass Group 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. 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.