SOCEP (BVB:SOCP) Is Posting Healthy Earnings, But It Is Not All Good News

SOCEP S.A.'s (BVB:SOCP) stock rose after it released a robust earnings report. However, we think that shareholders should be aware of some other factors beyond the profit numbers.

View our latest analysis for SOCEP

Examining Cashflow Against SOCEP'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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, SOCEP recorded an accrual ratio of 0.32. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Indeed, in the last twelve months it reported free cash flow of RON21m, which is significantly less than its profit of RON122.3m. SOCEP shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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 SOCEP.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, SOCEP increased the number of shares on issue by 85% over the last twelve months by issuing new shares. That means its earnings are split among 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 SOCEP's historical EPS growth by clicking on this link.

A Look At The Impact Of SOCEP's Dilution On Its Earnings Per Share (EPS)

SOCEP has improved its profit over the last three years, with an annualized gain of 1,105% in that time. And the 98% profit boost in the last year certainly seems impressive at first glance. But that's starkly different from the 11% drop in earnings per share. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If SOCEP'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 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 SOCEP's Profit Performance

In conclusion, SOCEP has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). Considering all this we'd argue SOCEP's profits probably give an overly generous impression of its sustainable level of profitability. 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. Case in point: We've spotted 3 warning signs for SOCEP you should be mindful of and 2 of these bad boys are a bit concerning.

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.