Impressive Earnings May Not Tell The Whole Story For DC Infotech and Communication (NSE:DCI)

DC Infotech and Communication Limited (NSE:DCI) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

See our latest analysis for DC Infotech and Communication

A Closer Look At DC Infotech and Communication'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

DC Infotech and Communication has an accrual ratio of 0.32 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of ₹86m, in contrast to the aforementioned profit of ₹116.1m. We also note that DC Infotech and Communication's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹86m. 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 DC Infotech and Communication.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, DC Infotech and Communication increased the number of shares on issue by 8.3% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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. Check out DC Infotech and Communication's historical EPS growth by clicking on this link.

How Is Dilution Impacting DC Infotech and Communication's Earnings Per Share (EPS)?

As you can see above, DC Infotech and Communication has been growing its net income over the last few years, with an annualized gain of 428% over three years. In comparison, earnings per share only gained 395% over the same period. And at a glance the 64% gain in profit over the last year impresses. But in comparison, EPS only increased by 54% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if DC Infotech and Communication can grow EPS persistently. 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 DC Infotech and Communication's Profit Performance

As it turns out, DC Infotech and Communication couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at DC Infotech and Communication'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 DC Infotech and Communication has 4 warning signs (2 are concerning!) that deserve your attention before going any further with your analysis.

Our examination of DC Infotech and Communication 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 are plenty of other ways to inform your opinion of a company. 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 with significant insider holdings 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.