Tenax International's (BIT:TNX) Solid Profits Have Weak Fundamentals

Tenax International S.p.A. (BIT:TNX) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for Tenax International

A Closer Look At Tenax International'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to June 2024, Tenax International had an accrual ratio of 0.24. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of €1.04m, a look at free cash flow indicates it actually burnt through €2.1m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of €2.1m, this year, indicates high risk. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Tenax International increased the number of shares on issue by 17% 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 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. You can see a chart of Tenax International's EPS by clicking here.

How Is Dilution Impacting Tenax International's Earnings Per Share (EPS)?

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. On the bright side, in the last twelve months it grew profit by 52%. But EPS was less impressive, up only 102% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Tenax International 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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Tenax International's Profit Performance

In conclusion, Tenax International 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 Tenax International's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Tenax International at this point in time. Be aware that Tenax International is showing 4 warning signs in our investment analysis and 2 of those are concerning...

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 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 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.