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Shareholders Shouldn’t Be Too Comfortable With Sedania Innovator Berhad's (KLSE:SEDANIA) Strong Earnings
Despite posting strong earnings, Sedania Innovator Berhad's (KLSE:SEDANIA) stock didn't move much over the last week. We think that investors might be worried about the foundations the earnings are built on.
View our latest analysis for Sedania Innovator Berhad
A Closer Look At Sedania Innovator Berhad'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 December 2021, Sedania Innovator Berhad had an accrual ratio of 0.37. 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 RM435k, in contrast to the aforementioned profit of RM8.52m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of RM435k, this year, indicates high risk. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. One positive for Sedania Innovator 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 Sedania Innovator Berhad.
To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Sedania Innovator Berhad expanded the number of shares on issue by 15% 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. Check out Sedania Innovator Berhad's historical EPS growth by clicking on this link.
A Look At The Impact Of Sedania Innovator Berhad's Dilution on Its Earnings Per Share (EPS).
Sedania Innovator Berhad was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, the dilution is having a noteworthy influence on shareholder returns.
If Sedania Innovator Berhad's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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 Sedania Innovator Berhad's Profit Performance
As it turns out, Sedania Innovator 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). Considering all this we'd argue Sedania Innovator Berhad's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 4 warning signs for Sedania Innovator Berhad (1 is a bit unpleasant) you should be familiar with.
In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About KLSE:SEDANIA
Sedania Innovator Berhad
An investment holding company, provides integrated telecommunications services in Malaysia, Europe, rest of Asia, and internationally.
Mediocre balance sheet and overvalued.