Rotem Shani Entrepreneurship and Investment's (TLV:RTSN) Earnings Might Be Weaker Than You Think

Shareholders didn't seem to be thrilled with Rotem Shani Entrepreneurship and Investment Ltd.'s (TLV:RTSN) recent earnings report, despite healthy profit numbers. Our analysis has found some concerning factors which weaken the profit's foundation.

View our latest analysis for Rotem Shani Entrepreneurship and Investment

Examining Cashflow Against Rotem Shani Entrepreneurship and Investment'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). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. 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".

Rotem Shani Entrepreneurship and Investment has an accrual ratio of 0.50 for the year to December 2023. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of ₪111m, in contrast to the aforementioned profit of ₪58.7m. It's worth noting that Rotem Shani Entrepreneurship and Investment generated positive FCF of ₪62m a year ago, so at least they've done it in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings. The good news for shareholders is that Rotem Shani Entrepreneurship and Investment's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Rotem Shani Entrepreneurship and Investment.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Rotem Shani Entrepreneurship and Investment issued 8.4% more new shares over the last year. As a result, its net income is now split between 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 Rotem Shani Entrepreneurship and Investment's historical EPS growth by clicking on this link.

How Is Dilution Impacting Rotem Shani Entrepreneurship and Investment's Earnings Per Share (EPS)?

As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. On the bright side, in the last twelve months it grew profit by 88%. But EPS was less impressive, up only 81% 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 Rotem Shani Entrepreneurship and Investment 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 Rotem Shani Entrepreneurship and Investment's Profit Performance

In conclusion, Rotem Shani Entrepreneurship and Investment 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 Rotem Shani Entrepreneurship and Investment's statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've found that Rotem Shani Entrepreneurship and Investment has 5 warning signs (3 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

Our examination of Rotem Shani Entrepreneurship and Investment 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. Some people consider a high return on equity to be a good sign of a quality business. 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.