STARLUX Airlines' (TWSE:2646) Shareholders Should Assess Earnings With Caution

Despite posting strong earnings, STARLUX Airlines Co., Ltd.'s (TWSE:2646) stock didn't move much over the last week. We think that investors might be worried about the foundations the earnings are built on.

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A Closer Look At STARLUX Airlines' 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.

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.

STARLUX Airlines has an accrual ratio of 0.35 for the year to December 2024. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of NT$1.32b, a look at free cash flow indicates it actually burnt through NT$13b in the last year. We also note that STARLUX Airlines' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$13b. 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. As it happens, STARLUX Airlines issued 44% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of STARLUX Airlines' EPS by clicking here.

How Is Dilution Impacting STARLUX Airlines' Earnings Per Share (EPS)?

STARLUX Airlines was losing money three years ago. The good news is that profit was up 788% in the last twelve months. On the other hand, earnings per share are only up 593% over the same period. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So STARLUX Airlines shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On STARLUX Airlines' Profit Performance

As it turns out, STARLUX Airlines 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 STARLUX Airlines' statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about STARLUX Airlines as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that STARLUX Airlines has 3 warning signs and it would be unwise to ignore them.

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 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.