Huisen Shares Group Limited (HKG:2127) recently posted soft earnings but shareholders didn't react strongly. We did some analysis and found some concerning details beneath the statutory profit number.

Examining Cashflow Against Huisen Shares Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Huisen Shares Group has an accrual ratio of 0.51 for the year to December 2023. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥2.0b despite its profit of CN¥207.1m, mentioned above. We also note that Huisen Shares Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥2.0b. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Huisen Shares Group.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Huisen Shares Group increased the number of shares on issue by 20% 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. You can see a chart of Huisen Shares Group's EPS by clicking here.

How Is Dilution Impacting Huisen Shares Group's Earnings Per Share (EPS)?

Unfortunately, Huisen Shares Group's profit is down 62% per year over three years. And even focusing only on the last twelve months, we see profit is down 38%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 38% in the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Huisen Shares Group's earnings per share can increase, then the share price should too. 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 Huisen Shares Group's Profit Performance

In conclusion, Huisen Shares Group 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 Huisen Shares Group's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Huisen Shares Group, you'd also look into what risks it is currently facing. To help with this, we've discovered 5 warning signs (2 don't sit too well with us!) that you ought to be aware of before buying any shares in Huisen Shares Group.

Our examination of Huisen Shares Group 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 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.