We Believe Mekdam Holding Group - Q.P.S.C's (DSM:MKDM) Earnings Are A Poor Guide For Its Profitability

Even though Mekdam Holding Group - Q.P.S.C. (DSM:MKDM) posted strong earnings recently, the stock hasn't reacted in a large way. We think that investors might be worried about the foundations the earnings are built on.

View our latest analysis for Mekdam Holding Group - Q.P.S.C

Examining Cashflow Against Mekdam Holding Group - Q.P.S.C'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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.

Mekdam Holding Group - Q.P.S.C has an accrual ratio of 0.35 for the year to June 2024. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of ر.ق38.1m, a look at free cash flow indicates it actually burnt through ر.ق32m in the last year. We saw that FCF was ر.ق12m a year ago though, so Mekdam Holding Group - Q.P.S.C has at least been able to generate positive FCF in the past. 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 Mekdam Holding Group - Q.P.S.C.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Mekdam Holding Group - Q.P.S.C issued 40% more new shares over the last year. That means its earnings are split among a greater number of shares. 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 Mekdam Holding Group - Q.P.S.C's EPS by clicking here.

A Look At The Impact Of Mekdam Holding Group - Q.P.S.C's Dilution On Its Earnings Per Share (EPS)

Mekdam Holding Group - Q.P.S.C has improved its profit over the last three years, with an annualized gain of 55% in that time. But EPS was only up 17% per year, in the exact same period. And in the last year the company managed to bump profit up by 7.8%. But earnings per share are actually down 19%, over the last twelve months. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Mekdam Holding Group - Q.P.S.C'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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Mekdam Holding Group - Q.P.S.C's Profit Performance

As it turns out, Mekdam Holding Group - Q.P.S.C 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). For the reasons mentioned above, we think that a perfunctory glance at Mekdam Holding Group - Q.P.S.C's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Mekdam Holding Group - Q.P.S.C as a business, it's important to be aware of any risks it's facing. Be aware that Mekdam Holding Group - Q.P.S.C is showing 2 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com