Why HighPeak Energy's (NASDAQ:HPK) Shaky Earnings Are Just The Beginning Of Its Problems

Investors were disappointed by HighPeak Energy, Inc.'s (NASDAQ:HPK ) latest earnings release. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

Check out our latest analysis for HighPeak Energy

A Closer Look At HighPeak Energy'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). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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 December 2023, HighPeak Energy had an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of US$269m despite its profit of US$194.0m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of US$269m, this year, indicates high risk. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

Our data indicates that HighPeak Energy insiders have been buying shares! Luckily we are in a position to provide you with this free chart of of all insider buying (and selling).

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, HighPeak Energy increased the number of shares on issue by 13% over the last twelve months by issuing new shares. 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. Check out HighPeak Energy's historical EPS growth by clicking on this link.

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

Three years ago, HighPeak Energy lost money. Even looking at the last year, profit was still down 9.3%. Sadly, earnings per share fell further, down a full 19% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

If HighPeak Energy'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 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 HighPeak Energy's Profit Performance

In conclusion, HighPeak Energy has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at HighPeak Energy's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into HighPeak Energy, you'd also look into what risks it is currently facing. To help with this, we've discovered 4 warning signs (2 shouldn't be ignored!) that you ought to be aware of before buying any shares in HighPeak Energy.

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. 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.