Ximei Resources Holding Limited (HKG:9936) posted some decent earnings, but shareholders didn't react strongly. We think that they might be concerned about some underlying details that our analysis found.

View our latest analysis for Ximei Resources Holding

A Closer Look At Ximei Resources Holding'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

Over the twelve months to June 2022, Ximei Resources Holding recorded an accrual ratio of 0.47. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥294m despite its profit of CN¥115.0m, mentioned above. It's worth noting that Ximei Resources Holding generated positive FCF of CN¥17m 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 Ximei Resources Holding.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Ximei Resources Holding increased the number of shares on issue by 20% over the last twelve months by issuing new shares. As a result, its net income is now split between 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. Check out Ximei Resources Holding's historical EPS growth by clicking on this link.

A Look At The Impact Of Ximei Resources Holding's Dilution On Its Earnings Per Share (EPS)

As you can see above, Ximei Resources Holding has been growing its net income over the last few years, with an annualized gain of 57% over three years. But EPS was only up 18% per year, in the exact same period. And at a glance the 37% gain in profit over the last year impresses. On the other hand, earnings per share are only up 37% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Ximei Resources Holding shareholders will want to see that EPS figure continue to increase. 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 Ximei Resources Holding's Profit Performance

As it turns out, Ximei Resources Holding couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at Ximei Resources Holding's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Ximei Resources Holding, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Ximei Resources Holding (2 are a bit unpleasant) you should be familiar with.

Our examination of Ximei Resources Holding 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. Some people consider a high return on equity to be a good sign of a quality business. 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.