TopGum Industries' (TLV:TPGM) Problems Go Beyond Poor Profit

TopGum Industries Ltd. (TLV:TPGM) recently posted soft earnings but shareholders didn't react strongly. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

See our latest analysis for TopGum Industries

Zooming In On TopGum Industries' 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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, TopGum Industries recorded an accrual ratio of 0.49. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of US$25m, in contrast to the aforementioned profit of US$3.21m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of US$25m, this year, indicates high risk. 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 TopGum Industries.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, TopGum Industries increased the number of shares on issue by 14% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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. You can see a chart of TopGum Industries' EPS by clicking here.

How Is Dilution Impacting TopGum Industries' Earnings Per Share (EPS)?

TopGum Industries has improved its profit over the last three years, with an annualized gain of 285% in that time. But EPS was only up 121% per year, in the exact same period. Net profit actually dropped by 12% in the last year. But the EPS result was even worse, with the company recording a decline of 22%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if TopGum Industries' earnings per share can increase, then the share price should too. 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 TopGum Industries' Profit Performance

In conclusion, TopGum Industries has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at TopGum Industries' statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 2 warning signs (1 shouldn't be ignored!) that you ought to be aware of before buying any shares in TopGum Industries.

Our examination of TopGum Industries 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. 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. 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.