We Think That There Are More Issues For SCI Pharmtech (TWSE:4119) Than Just Sluggish Earnings

Shareholders didn't appear too concerned by SCI Pharmtech, Inc.'s (TWSE:4119) weak earnings. We did some analysis and found some concerning details beneath the statutory profit number.

Check out our latest analysis for SCI Pharmtech

Examining Cashflow Against SCI Pharmtech'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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2023, SCI Pharmtech had an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of NT$294.7m, a look at free cash flow indicates it actually burnt through NT$814m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of NT$814m, this year, indicates high risk. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of SCI Pharmtech.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, SCI Pharmtech issued 11% more new shares over the last year. 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. Check out SCI Pharmtech's historical EPS growth by clicking on this link.

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

Unfortunately, SCI Pharmtech's profit is down 18% per year over three years. Even looking at the last year, profit was still down 4.6%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 6.3% in the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if SCI Pharmtech'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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that SCI Pharmtech's profit was boosted by unusual items worth NT$209m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. We can see that SCI Pharmtech's positive unusual items were quite significant relative to its profit in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On SCI Pharmtech's Profit Performance

SCI Pharmtech didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. On reflection, the above-mentioned factors give us the strong impression that SCI Pharmtech'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you'd like to know more about SCI Pharmtech as a business, it's important to be aware of any risks it's facing. For example, we've found that SCI Pharmtech has 3 warning signs (2 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

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 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.