Some Investors May Be Willing To Look Past Shagrir Group Vehicle Services' (TLV:SHGR) Soft Earnings

Soft earnings didn't appear to concern Shagrir Group Vehicle Services Ltd's (TLV:SHGR) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

See our latest analysis for Shagrir Group Vehicle Services

Examining Cashflow Against Shagrir Group Vehicle Services' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 2020, Shagrir Group Vehicle Services recorded an accrual ratio of -0.17. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of ₪21m in the last year, which was a lot more than its statutory profit of ₪5.70m. Shagrir Group Vehicle Services' 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 Shagrir Group Vehicle Services.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Shagrir Group Vehicle Services increased the number of shares on issue by 18% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Shagrir Group Vehicle Services' historical EPS growth by clicking on this link.

A Look At The Impact Of Shagrir Group Vehicle Services' Dilution on Its Earnings Per Share (EPS).

Shagrir Group Vehicle Services' net profit dropped by 62% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 70%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 70% in the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Shagrir Group Vehicle Services' earnings per share can increase, then the share price should too. 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 Shagrir Group Vehicle Services' Profit Performance

In conclusion, Shagrir Group Vehicle Services has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Based on these factors, we think that Shagrir Group Vehicle Services' profits are a reasonably conservative guide to its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing Shagrir Group Vehicle Services at this point in time. You'd be interested to know, that we found 4 warning signs for Shagrir Group Vehicle Services and you'll want to know about these.

Our examination of Shagrir Group Vehicle Services 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. 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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