The market shrugged off Many Idea Cloud Holdings Limited's (HKG:6696) weak earnings report. Despite the strength in the stock, we feel that investors should be cautious about some numbers in the earnings.

Zooming In On Many Idea Cloud Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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, Many Idea Cloud Holdings recorded an accrual ratio of 0.36. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥185m, in contrast to the aforementioned profit of CN¥19.8m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥185m, this year, indicates high risk. 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 Many Idea Cloud Holdings.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Many Idea Cloud Holdings expanded the number of shares on issue by 70% over the last year. Therefore, each share now receives a smaller portion of profit. 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 Many Idea Cloud Holdings' EPS by clicking here.

A Look At The Impact Of Many Idea Cloud Holdings' Dilution On Its Earnings Per Share (EPS)

Unfortunately, Many Idea Cloud Holdings' profit is down 52% per year over three years. Even looking at the last year, profit was still down 71%. Sadly, earnings per share fell further, down a full 76% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, if Many Idea Cloud Holdings' earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Many Idea Cloud Holdings' Profit Performance

As it turns out, Many Idea Cloud Holdings couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For the reasons mentioned above, we think that a perfunctory glance at Many Idea Cloud Holdings' statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To help with this, we've discovered 5 warning signs (3 are a bit unpleasant!) that you ought to be aware of before buying any shares in Many Idea Cloud Holdings.

Our examination of Many Idea Cloud Holdings 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 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.