Norconsult's (OB:NORCO) Strong Earnings Are Of Good Quality

Norconsult ASA (OB:NORCO) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.

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A Closer Look At Norconsult'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. 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.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Norconsult has an accrual ratio of -0.35 for the year to March 2025. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of kr1.1b during the period, dwarfing its reported profit of kr650.0m. Norconsult'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.

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. Norconsult expanded the number of shares on issue by 5.5% over the last year. Therefore, each share now receives a smaller portion of profit. 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. You can see a chart of Norconsult's EPS by clicking here.

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

As you can see above, Norconsult has been growing its net income over the last few years, with an annualized gain of 76% over three years. And at a glance the 93% gain in profit over the last year impresses. On the other hand, earnings per share are only up 87% 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 Norconsult 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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Norconsult's Profit Performance

In conclusion, Norconsult 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. Considering all the aforementioned, we'd venture that Norconsult's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. Given that we think the earnings are a decent guide to the business, it might be worth looking at its share price. Given that Norconsult has managed to grow its earnings, it may well have an above average P/E ratio.Click here to find out!

Our examination of Norconsult has focussed on certain factors that can make its earnings look better than they are. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.