Are PeterLabs Holdings Berhad's (KLSE:PLABS) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. This article will consider whether PeterLabs Holdings Berhad's (KLSE:PLABS) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months PeterLabs Holdings Berhad made a profit of RM4.11m on revenue of RM89.6m. Interestingly, even though its revenue has been flat over the last few years, its profit has actually increased, as you can see, below.

See our latest analysis for PeterLabs Holdings Berhad

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we'll today take a look at how dilution and cashflow shape our understanding of PeterLabs Holdings Berhad's earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of PeterLabs Holdings Berhad.

Examining Cashflow Against PeterLabs Holdings 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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2020, PeterLabs Holdings Berhad had an accrual ratio of -0.18. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of RM12m in the last year, which was a lot more than its statutory profit of RM4.11m. PeterLabs Holdings Berhad's free cash flow improved over the last year, which is generally good to see. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, PeterLabs Holdings Berhad issued 10.0% more new shares over the last year. That means its earnings are split among 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. Check out PeterLabs Holdings Berhad's historical EPS growth by clicking on this link.

A Look At The Impact Of PeterLabs Holdings Berhad's Dilution on Its Earnings Per Share (EPS).

PeterLabs Holdings Berhad has improved its profit over the last three years, with an annualized gain of 9.9% in that time. And in the last year the company managed to bump profit up by 6.5%. On the other hand, earnings per share are only up 6.5% 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 PeterLabs Holdings Berhad 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 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 PeterLabs Holdings Berhad's Profit Performance

In conclusion, PeterLabs Holdings Berhad 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. Based on these factors, we think that PeterLabs Holdings Berhad's profits are a reasonably conservative guide to its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. You'd be interested to know, that we found 3 warning signs for PeterLabs Holdings Berhad and you'll want to know about these.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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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