Pacific Radiance Ltd.'s (SGX:RXS) solid earnings report last week was underwhelming to investors. We think that they may be worried about something else, so we did some analysis and found that investors have noticed some soft numbers underlying the profit.

See our latest analysis for Pacific Radiance

Examining Cashflow Against Pacific Radiance's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2022, Pacific Radiance recorded an accrual ratio of 4.22. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of US$4.3m in the last year, which was a lot less than its statutory profit of US$330.3m. Pacific Radiance shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. The good news for shareholders is that Pacific Radiance's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Pacific Radiance.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Pacific Radiance increased the number of shares on issue by 530% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Pacific Radiance's historical EPS growth by clicking on this link.

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

Pacific Radiance was losing money three years ago. The good news is that profit was up 3,274% in the last twelve months. But EPS was less impressive, up only 2,109% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Pacific Radiance 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 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 Pacific Radiance's Profit Performance

As it turns out, Pacific Radiance couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. On reflection, the above-mentioned factors give us the strong impression that Pacific Radiance'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that Pacific Radiance is showing 3 warning signs in our investment analysis and 2 of those shouldn't be ignored...

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 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.