A lackluster earnings announcement from BCEG Environmental Remediation Co., Ltd. (SZSE:300958) last week didn't sink the stock price. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

A Closer Look At BCEG Environmental Remediation'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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. 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 June 2024, BCEG Environmental Remediation recorded an accrual ratio of 0.24. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥239m, in contrast to the aforementioned profit of CN¥28.3m. It's worth noting that BCEG Environmental Remediation generated positive FCF of CN¥79m a year ago, so at least they've done it in the past. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of BCEG Environmental Remediation.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, BCEG Environmental Remediation increased the number of shares on issue by 9.9% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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 BCEG Environmental Remediation's EPS by clicking here.

A Look At The Impact Of BCEG Environmental Remediation's Dilution On Its Earnings Per Share (EPS)

BCEG Environmental Remediation's net profit dropped by 66% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 71%. Sadly, earnings per share fell further, down a full 77% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, if BCEG Environmental Remediation'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.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) BCEG Environmental Remediation saw its profit reduced by unusual items worth CN¥37m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. In the twelve months to June 2024, BCEG Environmental Remediation had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On BCEG Environmental Remediation's Profit Performance

Summing up, BCEG Environmental Remediation's unusual items suggest that its statutory earnings were temporarily depressed, and its accrual ratio indicates a lack of free cash flow relative to profit. On top of that, the dilution means that shareholders now own less of the company. Based on these factors, we think it's very unlikely that BCEG Environmental Remediation's statutory profits make it seem much weaker than it is. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, BCEG Environmental Remediation has 5 warning signs (and 2 which are potentially serious) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 with high insider ownership.

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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.