Impressive Earnings May Not Tell The Whole Story For Asia Vital Components (TWSE:3017)

Despite announcing strong earnings, Asia Vital Components Co., Ltd.'s (TWSE:3017) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

View our latest analysis for Asia Vital Components

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

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2023, Asia Vital Components recorded an accrual ratio of -0.11. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of NT$6.6b, well over the NT$5.30b it reported in profit. Asia Vital Components shareholders are no doubt pleased that free cash flow improved over the last twelve months. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.

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, Asia Vital Components issued 8.5% more new shares over the last year. 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. You can see a chart of Asia Vital Components' EPS by clicking here.

A Look At The Impact Of Asia Vital Components' Dilution On Its Earnings Per Share (EPS)

Asia Vital Components has improved its profit over the last three years, with an annualized gain of 177% in that time. In comparison, earnings per share only gained 160% over the same period. And the 27% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 20% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

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 Asia Vital Components 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 Asia Vital Components' Profit Performance

At the end of the day, Asia Vital Components 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. Given the contrasting considerations, we don't have a strong view as to whether Asia Vital Components's profits are an apt reflection of its underlying potential for profit. So while earnings quality is important, it's equally important to consider the risks facing Asia Vital Components at this point in time. When we did our research, we found 2 warning signs for Asia Vital Components (1 makes us a bit uncomfortable!) that we believe deserve your full attention.

Our examination of Asia Vital Components 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. 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.