The market wasn’t impressed with the soft earnings from Northern Oil and Gas, Inc. (NYSE:NOG) recently. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.
See our latest analysis for Northern Oil and Gas
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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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.
For the year to June 2024, Northern Oil and Gas had an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of US$277m despite its profit of US$565.1m, mentioned above. We also note that Northern Oil and Gas’ free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$277m. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Northern Oil and Gas expanded the number of shares on issue by 7.5% over the last year. That means its earnings are split among 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. You can see a chart of Northern Oil and Gas’ EPS by clicking here.
Three years ago, Northern Oil and Gas lost money. And even focusing only on the last twelve months, we see profit is down 54%. Sadly, earnings per share fell further, down a full 61% in that time. So you can see that the dilution has had a bit of an impact on shareholders.
If Northern Oil and Gas’ EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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.
As it turns out, Northern Oil and Gas 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 Northern Oil and Gas’ statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn’t consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 5 warning signs for Northern Oil and Gas (1 is potentially serious!) that we believe deserve your full attention.
Our examination of Northern Oil and Gas 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 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.