We Think That There Are Issues Underlying Ramssol Group Berhad's (KLSE:RAMSSOL) Earnings

Ramssol Group Berhad's (KLSE:RAMSSOL) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Ramssol Group Berhad

Zooming In On Ramssol Group Berhad'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Ramssol Group Berhad has an accrual ratio of 0.25 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of RM13.4m, a look at free cash flow indicates it actually burnt through RM8.1m in the last year. We also note that Ramssol Group Berhad's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM8.1m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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, Ramssol Group Berhad issued 8.3% more new shares over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Ramssol Group Berhad's EPS by clicking here.

A Look At The Impact Of Ramssol Group Berhad's Dilution On Its Earnings Per Share (EPS)

As you can see above, Ramssol Group Berhad has been growing its net income over the last few years, with an annualized gain of 92% over three years. But EPS was only up 8.2% per year, in the exact same period. And at a glance the 127% gain in profit over the last year impresses. On the other hand, earnings per share are only up 98% 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 Ramssol Group Berhad shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Ramssol Group Berhad's Profit Performance

In conclusion, Ramssol Group Berhad 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 Ramssol Group Berhad's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Ramssol Group Berhad at this point in time. For example, Ramssol Group Berhad has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Our examination of Ramssol Group 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. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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 with significant insider holdings to be useful.

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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.