Shareholders In Zen Technologies (NSE:ZENTEC) Should Look Beyond Earnings For The Full Story

Despite posting strong earnings, Zen Technologies Limited's (NSE:ZENTEC) stock didn't move much over the last week. We decided to have a deeper look, and we believe that investors might be worried about several concerning factors that we found.

View our latest analysis for Zen Technologies

Zooming In On Zen Technologies' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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 September 2024, Zen Technologies recorded an accrual ratio of 1.06. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₹1.6b despite its profit of ₹2.05b, mentioned above. It's worth noting that Zen Technologies generated positive FCF of ₹1.6b a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. One positive for Zen Technologies shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Zen Technologies expanded the number of shares on issue by 7.4% over the last year. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Zen Technologies' historical EPS growth by clicking on this link.

How Is Dilution Impacting Zen Technologies' Earnings Per Share (EPS)?

Zen Technologies has improved its profit over the last three years, with an annualized gain of 8,049% in that time. In comparison, earnings per share only gained 7,597% over the same period. And the 123% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 113% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So Zen Technologies shareholders will want to see that EPS figure continue to increase. 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 Zen Technologies' Profit Performance

As it turns out, Zen Technologies couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Zen Technologies' profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Zen Technologies, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Zen Technologies you should be mindful of and 1 of these is significant.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there are plenty of other ways to inform your opinion of a company. 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 with high insider ownership.

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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.