UCrest Berhad's (KLSE:UCREST) Earnings Aren't As Good As They Appear

After announcing healthy earnings, UCrest Berhad's (KLSE:UCREST) stock rose over the last week. While the headline numbers were strong, we found some underlying problems once we started looking at what drove earnings.

View our latest analysis for UCrest Berhad

A Closer Look At UCrest Berhad's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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".

UCrest Berhad has an accrual ratio of 0.87 for the year to November 2023. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of RM4.4m, in contrast to the aforementioned profit of RM6.36m. We also note that UCrest Berhad's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM4.4m. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. One positive for UCrest Berhad shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of UCrest Berhad.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. UCrest Berhad expanded the number of shares on issue by 19% over the last year. Therefore, each share now receives a smaller portion of profit. 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 UCrest Berhad's EPS by clicking here.

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

Three years ago, UCrest Berhad lost money. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if UCrest Berhad's earnings per share can increase, then the share price should too. 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 UCrest Berhad's Profit Performance

As it turns out, UCrest Berhad couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For the reasons mentioned above, we think that a perfunctory glance at UCrest Berhad'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 UCrest Berhad at this point in time. For example, UCrest Berhad has 5 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Our examination of UCrest 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 that insiders are buying 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.