Desiccant Technology's (TWSE:5292) Solid Earnings Are Supported By Other Strong Factors

Desiccant Technology Corporation (TWSE:5292) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

View our latest analysis for Desiccant Technology

A Closer Look At Desiccant Technology'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. 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. 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.

For the year to December 2023, Desiccant Technology had an accrual ratio of -0.21. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of NT$326m during the period, dwarfing its reported profit of NT$305.1m. Desiccant Technology's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. 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 Desiccant 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, Desiccant Technology increased the number of shares on issue by 13% over the last twelve months by issuing new shares. 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 Desiccant Technology's EPS by clicking here.

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

As you can see above, Desiccant Technology has been growing its net income over the last few years, with an annualized gain of 163% over three years. But EPS was only up 148% per year, in the exact same period. And at a glance the 26% gain in profit over the last year impresses. On the other hand, earnings per share are only up 23% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Desiccant Technology can grow EPS persistently. 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 Desiccant Technology's Profit Performance

At the end of the day, Desiccant Technology 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. Based on these factors, we think that Desiccant Technology's profits are a reasonably conservative guide to its underlying profitability. If you'd like to know more about Desiccant Technology as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 1 warning sign for Desiccant Technology and you'll want to know about this.

Our examination of Desiccant Technology has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.