Drilling Tools International (NASDAQ:DTI) Posted Weak Earnings But There Is More To Worry About

The recent earnings release from Drilling Tools International Corporation (NASDAQ:DTI ) was disappointing to investors. We looked deeper and believe that there is even more to be worried about, beyond the soft profit numbers.

View our latest analysis for Drilling Tools International

A Closer Look At Drilling Tools International's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Drilling Tools International has an accrual ratio of 0.37 for the year to June 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of US$11.6m, a look at free cash flow indicates it actually burnt through US$22m in the last year. We also note that Drilling Tools International's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$22m. 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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Drilling Tools International issued 17% more new shares 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 Drilling Tools International's EPS by clicking here.

How Is Dilution Impacting Drilling Tools International's Earnings Per Share (EPS)?

Drilling Tools International was losing money three years ago. And even focusing only on the last twelve months, we see profit is down 41%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 75% in the same period. So you can see that the dilution has had a bit of an impact on shareholders.

If Drilling Tools International's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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 Drilling Tools International's Profit Performance

As it turns out, Drilling Tools International couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For the reasons mentioned above, we think that a perfunctory glance at Drilling Tools International's statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To that end, you should learn about the 4 warning signs we've spotted with Drilling Tools International (including 1 which doesn't sit too well with us).

Our examination of Drilling Tools International 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 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 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.