River Tech's (OB:RIVER) Sluggish Earnings Might Be Just The Beginning Of Its Problems

The subdued market reaction suggests that River Tech p.l.c.'s (OB:RIVER) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for River Tech

Examining Cashflow Against River Tech'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.

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.

River Tech has an accrual ratio of -0.80 for the year to December 2021. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of €6.3m in the last year, which was a lot more than its statutory profit of €4.43m. River Tech shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. River Tech expanded the number of shares on issue by 7.5% 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 River Tech's historical EPS growth by clicking on this link.

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

River Tech was losing money three years ago. And even focusing only on the last twelve months, we see profit is down 65%. Sadly, earnings per share fell further, down a full 65% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

If River Tech's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that River Tech's profit was boosted by unusual items worth €501k in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On River Tech's Profit Performance

In conclusion, River Tech's accrual ratio suggests its earnings are well backed by cash but its boost from unusual items is probably not going to be repeated consistently. Meanwhile, the dilution was a negative for shareholders. Based on these factors, we think it's very unlikely that River Tech's statutory profits make it seem much weaker than it is. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. When we did our research, we found 5 warning signs for River Tech (2 are concerning!) that we believe deserve your full attention.

Our examination of River Tech 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. 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.