We Think That There Are Issues Underlying Skytech's (TWSE:6937) Earnings

Investors were disappointed with Skytech Inc.'s (TWSE:6937) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

View our latest analysis for Skytech

Examining Cashflow Against Skytech'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 2024, Skytech recorded an accrual ratio of 0.30. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of NT$408.7m, a look at free cash flow indicates it actually burnt through NT$293m 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$293m, this year, indicates high risk. 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 Skytech.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Skytech expanded the number of shares on issue by 11% over the last year. 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. You can see a chart of Skytech's EPS by clicking here.

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

Skytech has improved its profit over the last three years, with an annualized gain of 128% in that time. In comparison, earnings per share only gained 61% over the same period. And at a glance the 47% gain in profit over the last year impresses. On the other hand, earnings per share are only up 34% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

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 Skytech 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 Skytech's Profit Performance

As it turns out, Skytech couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Skytech's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Skytech, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Skytech (1 can't be ignored!) that we believe deserve your full attention.

Our examination of Skytech 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. 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 with significant insider holdings to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.