The Strong Earnings Posted By Dominion Hosting Holding (BIT:DHH) Are A Good Indication Of The Strength Of The Business

Dominion Hosting Holding S.p.A. (BIT:DHH) 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 Dominion Hosting Holding

Examining Cashflow Against Dominion Hosting Holding'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. 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.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2021, Dominion Hosting Holding recorded an accrual ratio of -0.28. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of €4.9m during the period, dwarfing its reported profit of €2.49m. Notably, Dominion Hosting Holding had negative free cash flow last year, so the €4.9m it produced this year was a welcome improvement. 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. As it happens, Dominion Hosting Holding issued 213% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. 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 Dominion Hosting Holding's historical EPS growth by clicking on this link.

How Is Dilution Impacting Dominion Hosting Holding's Earnings Per Share? (EPS)

Dominion Hosting Holding has improved its profit over the last three years, with an annualized gain of 884% in that time. But EPS was only up 314% per year, in the exact same period. And at a glance the 836% gain in profit over the last year impresses. On the other hand, earnings per share are only up 322% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Dominion Hosting Holding 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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Dominion Hosting Holding's Profit Performance

In conclusion, Dominion Hosting Holding has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Given the contrasting considerations, we don't have a strong view as to whether Dominion Hosting Holding's profits are an apt reflection of its underlying potential for profit. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 2 warning signs for Dominion Hosting Holding (1 is a bit unpleasant!) and we strongly recommend you look at them before investing.

Our examination of Dominion Hosting Holding has focussed on certain factors that can make its earnings look better than they are. 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. 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.

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.

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