Statutory Profit Doesn't Reflect How Good Medika d.d's (ZGSE:MDKA) Earnings Are

The subdued stock price reaction suggests that Medika d.d.'s (ZGSE:MDKA) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for Medika d.d

Zooming In On Medika d.d's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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'.

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. 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 2021, Medika d.d recorded an accrual ratio of -0.22. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of Kn291m in the last year, which was a lot more than its statutory profit of Kn92.4m. Given that Medika d.d had negative free cash flow in the prior corresponding period, the trailing twelve month resul of Kn291m would seem to be a step in the right direction. 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 Medika d.d.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Medika d.d increased the number of shares on issue by 6.2% over the last twelve months by issuing new shares. 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 Medika d.d's EPS by clicking here.

How Is Dilution Impacting Medika d.d's Earnings Per Share? (EPS)

Medika d.d has improved its profit over the last three years, with an annualized gain of 99% in that time. And at a glance the 42% gain in profit over the last year impresses. On the other hand, earnings per share are only up 28% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

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

At the end of the day, Medika d.d 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 Medika d.d's profits are a reasonably conservative guide to its underlying profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. At Simply Wall St, we found 4 warning signs for Medika d.d and we think they deserve your attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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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