Shareholders Can Be Confident That Labo Print's (WSE:LAB) Earnings Are High Quality

Labo Print S.A. (WSE:LAB) 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.

See our latest analysis for Labo Print

Zooming In On Labo Print'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.

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

Labo Print has an accrual ratio of -0.14 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 zł13m in the last year, which was a lot more than its statutory profit of zł6.26m. Labo Print'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.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Labo Print expanded the number of shares on issue by 5.4% over the last year. As a result, its net income is now split between 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 Labo Print's historical EPS growth by clicking on this link.

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

As you can see above, Labo Print has been growing its net income over the last few years, with an annualized gain of 92% over three years. And at a glance the 44% gain in profit over the last year impresses. On the other hand, earnings per share are only up 37% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Labo Print 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 Labo Print's Profit Performance

At the end of the day, Labo Print is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Considering all the aforementioned, we'd venture that Labo Print's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing Labo Print at this point in time. For example - Labo Print has 3 warning signs we think you should be aware of.

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. 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 that insiders are buying.

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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.