Phihong Technology (TWSE:2457) Is Posting Promising Earnings But The Good News Doesn’t Stop There

The market seemed underwhelmed by last week's earnings announcement from Phihong Technology Co., Ltd. (TWSE:2457) despite the healthy numbers. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

See our latest analysis for Phihong Technology

Examining Cashflow Against Phihong Technology'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Phihong Technology has an accrual ratio of -0.25 for the year to December 2023. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$1.7b during the period, dwarfing its reported profit of NT$262.6m. Notably, Phihong Technology had negative free cash flow last year, so the NT$1.7b it produced this year was a welcome improvement. 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 Phihong Technology.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Phihong Technology increased the number of shares on issue by 15% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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 Phihong Technology's EPS by clicking here.

How Is Dilution Impacting Phihong Technology's Earnings Per Share (EPS)?

Three years ago, Phihong Technology lost money. The good news is that profit was up 268% in the last twelve months. On the other hand, earnings per share are only up 259% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Phihong Technology can grow EPS persistently. 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 Phihong Technology's Profit Performance

In conclusion, Phihong Technology has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Considering all the aforementioned, we'd venture that Phihong Technology'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 Phihong Technology at this point in time. At Simply Wall St, we found 1 warning sign for Phihong Technology and we think they deserve your attention.

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 are plenty of other ways to inform your opinion of a company. 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 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.