Following the release of a positive earnings report recently, Avangaad Berhad’s (KLSE:EATECH) stock performed well. Despite this, we feel that there are some reasons to be cautious with these earnings.
View our latest analysis for Avangaad Berhad
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. 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. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Over the twelve months to December 2024, Avangaad Berhad recorded an accrual ratio of 0.63. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn’t produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of RM67m, in contrast to the aforementioned profit of RM154.3m. It’s worth noting that Avangaad Berhad generated positive FCF of RM8.9m a year ago, so at least they’ve done it in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Avangaad Berhad.
To understand the value of a company’s earnings growth, it is imperative to consider any dilution of shareholders’ interests. In fact, Avangaad Berhad increased the number of shares on issue by 150% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. 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 Avangaad Berhad’s EPS by clicking here.
Three years ago, Avangaad Berhad lost money. The good news is that profit was up 551% in the last twelve months. But EPS was less impressive, up only 268% in that time. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.
Read More: Avangaad Berhad’s (KLSE:EATECH) Earnings Might Not Be As Promising As They
