Statutory Earnings May Not Be The Best Way To Understand Sarawak Consolidated Industries Berhad's (KLSE:SCIB) True Position

Despite posting strong earnings, Sarawak Consolidated Industries Berhad's (KLSE:SCIB) 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.

See our latest analysis for Sarawak Consolidated Industries Berhad

Zooming In On Sarawak Consolidated Industries Berhad'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 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.

Sarawak Consolidated Industries Berhad has an accrual ratio of 0.99 for the year to June 2021. Statistically speaking, that's a real negative for future earnings. 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 RM36m despite its profit of RM87.7m, mentioned above. We also note that Sarawak Consolidated Industries Berhad's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM36m. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Sarawak Consolidated Industries Berhad.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Sarawak Consolidated Industries Berhad increased the number of shares on issue by 7.2% over the last twelve months by issuing new shares. 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 Sarawak Consolidated Industries Berhad's historical EPS growth by clicking on this link.

How Is Dilution Impacting Sarawak Consolidated Industries Berhad's Earnings Per Share? (EPS)

Three years ago, Sarawak Consolidated Industries Berhad lost money. On the bright side, in the last twelve months it grew profit by 696%. But EPS was less impressive, up only 362% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

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 Sarawak Consolidated Industries Berhad can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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 Sarawak Consolidated Industries Berhad's Profit Performance

As it turns out, Sarawak Consolidated Industries Berhad 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 Sarawak Consolidated Industries Berhad's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Sarawak Consolidated Industries Berhad, you'd also look into what risks it is currently facing. For instance, we've identified 5 warning signs for Sarawak Consolidated Industries Berhad (1 is a bit concerning) you should be familiar with.

Our examination of Sarawak Consolidated Industries Berhad 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.