Tesna (KOSDAQ:131970) Is Growing Earnings But Are They A Good Guide?

Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Tesna (KOSDAQ:131970).

We like the fact that Tesna made a profit of ₩20.7b on its revenue of ₩119.9b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

See our latest analysis for Tesna

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll examine what Tesna's cashflow and its expanding share count tell us about the nature of its profits. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tesna.

Zooming In On Tesna's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. 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 2020, Tesna recorded an accrual ratio of 0.76. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of ₩117b despite its profit of ₩20.7b, mentioned above. We also note that Tesna's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩117b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Tesna expanded the number of shares on issue by 8.0% over the last year. That means its earnings are split among 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. You can see a chart of Tesna's EPS by clicking here.

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

Tesna has improved its profit over the last three years, with an annualized gain of 242% in that time. But EPS was only up 202% per year, in the exact same period. And the 22% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 5.3% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. 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 Tesna 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 Tesna's Profit Performance

In conclusion, Tesna 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. Considering all this we'd argue Tesna's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Tesna as a business, it's important to be aware of any risks it's facing. Our analysis shows 4 warning signs for Tesna (1 is concerning!) and we strongly recommend you look at these before investing.

Our examination of Tesna 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 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. 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. 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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