Shareholders In Starbreeze (STO:STAR B) Should Look Beyond Earnings For The Full Story

After announcing healthy earnings, Starbreeze AB (publ)'s (STO:STAR B) stock rose over the last week. However, we think that shareholders should be aware of some other factors beyond the profit numbers.

See our latest analysis for Starbreeze

Zooming In On Starbreeze'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Starbreeze has an accrual ratio of 0.59 for the year to March 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of kr32m, in contrast to the aforementioned profit of kr211.5m. We also note that Starbreeze's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of kr32m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Starbreeze increased the number of shares on issue by 104% over the last twelve months by issuing new shares. As a result, its net income is now split between 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. Check out Starbreeze's historical EPS growth by clicking on this link.

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

Starbreeze was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, if Starbreeze's earnings per share can increase, then the share price should too. 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 Starbreeze's Profit Performance

As it turns out, Starbreeze 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). On reflection, the above-mentioned factors give us the strong impression that Starbreeze'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you want to do dive deeper into Starbreeze, you'd also look into what risks it is currently facing. To help with this, we've discovered 5 warning signs (3 can't be ignored!) that you ought to be aware of before buying any shares in Starbreeze.

Our examination of Starbreeze has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.