Why Groundhog's (TWSE:6906) Earnings Are Weaker Than They Seem

Investors were disappointed with Groundhog Inc.'s (TWSE:6906) recent earnings release. We did some analysis and believe that they might be concerned about some weak underlying factors.

Check out our latest analysis for Groundhog

A Closer Look At Groundhog'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. 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 September 2024, Groundhog had an accrual ratio of 1.37. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of NT$60m during the period, falling well short of its reported profit of NT$110.9m. At this point we should mention that Groundhog did manage to increase its free cash flow in the last twelve months Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Groundhog expanded the number of shares on issue by 9.8% over the last year. As a result, its net income is now split between 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. You can see a chart of Groundhog's EPS by clicking here.

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

Groundhog has improved its profit over the last three years, with an annualized gain of 179% in that time. But EPS was only up 146% per year, in the exact same period. And the 63% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 52% 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 Groundhog 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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Groundhog's Profit Performance

As it turns out, Groundhog couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at Groundhog's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Groundhog as a business, it's important to be aware of any risks it's facing. For example, Groundhog has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Our examination of Groundhog 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.

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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.