Are Rich Honour International Designs' (TPE:6754) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Rich Honour International Designs (TPE:6754).

It's good to see that over the last twelve months Rich Honour International Designs made a profit of NT$156.2m on revenue of NT$3.50b. One positive is that it has grown both its profit and its revenue, over the last few years, though not in the last twelve months.

See our latest analysis for Rich Honour International Designs

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll examine what Rich Honour International Designs' cashflow and its expanding share count tell us about the nature of its profits. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Rich Honour International Designs.

Zooming In On Rich Honour International Designs' 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. 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'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2020, Rich Honour International Designs recorded an accrual ratio of -0.22. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of NT$362m in the last year, which was a lot more than its statutory profit of NT$156.2m. Rich Honour International Designs' free cash flow improved over the last year, which is generally good to see. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Rich Honour International Designs increased the number of shares on issue by 10.0% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Rich Honour International Designs' historical EPS growth by clicking on this link.

How Is Dilution Impacting Rich Honour International Designs' Earnings Per Share? (EPS)

Rich Honour International Designs has improved its profit over the last three years, with an annualized gain of 68% in that time. In comparison, earnings per share only gained over the same period. Net profit actually dropped by 39% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 46%. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Rich Honour International Designs' 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 Rich Honour International Designs' Profit Performance

In conclusion, Rich Honour International Designs has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Considering all the aforementioned, we'd venture that Rich Honour International Designs' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about Rich Honour International Designs as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for Rich Honour International Designs you should be aware of.

Our examination of Rich Honour International Designs has focussed on certain factors that can make its earnings look better than they are. 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. 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. 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.
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