Polyram Plastic Industries' (TLV:POLP) Conservative Accounting Might Explain Soft Earnings

The market for Polyram Plastic Industries LTD's (TLV:POLP) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

Check out our latest analysis for Polyram Plastic Industries

Zooming In On Polyram Plastic Industries' 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'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2023, Polyram Plastic Industries recorded an accrual ratio of -0.19. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of ₪235m during the period, dwarfing its reported profit of ₪81.7m. Polyram Plastic Industries' free cash flow improved over the last year, which is generally good to see. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Polyram Plastic 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, Polyram Plastic Industries increased the number of shares on issue by 6.9% 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 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 Polyram Plastic Industries' EPS by clicking here.

A Look At The Impact Of Polyram Plastic Industries' Dilution On Its Earnings Per Share (EPS)

As you can see above, Polyram Plastic Industries has been growing its net income over the last few years, with an annualized gain of 32% over three years. Net income was down 19% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 19%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Polyram Plastic Industries' EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Polyram Plastic Industries' Profit Performance

In conclusion, Polyram Plastic Industries 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 Polyram Plastic Industries' profits are a reasonably conservative guide to its underlying profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. While conducting our analysis, we found that Polyram Plastic Industries has 2 warning signs and it would be unwise to ignore them.

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 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.