Despite posting some strong earnings, the market for Hume Cement Industries Berhad’s (KLSE:HUMEIND) stock hasn’t moved much. We did some digging, and we found some concerning factors in the details.
See our latest analysis for Hume Cement Industries Berhad
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). 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’.
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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to June 2024, Hume Cement Industries Berhad recorded an accrual ratio of -0.14. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of RM330m, well over the RM210.9m it reported in profit. Hume Cement Industries Berhad’s free cash flow improved over the last year, which is generally good to see. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.
One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Hume Cement Industries Berhad expanded the number of shares on issue by 42% over the last year. 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. You can see a chart of Hume Cement Industries Berhad’s EPS by clicking here.
Three years ago, Hume Cement Industries Berhad lost money. On the bright side, in the last twelve months it grew profit by 251%. On the other hand, earnings per share are only up 203% over the same period. So you can see that the dilution has had a fairly significant impact on shareholders.
In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Hume Cement Industries Berhad can grow EPS persistently. 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.
At the end of the day, Hume Cement Industries Berhad is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Having considered these factors, we don’t think Hume Cement Industries Berhad’s statutory profits give an overly harsh view of the business. Keep in mind, when it comes to analysing a stock it’s worth noting the risks involved. While conducting our analysis, we found that Hume Cement Industries Berhad has 2 warning signs and it would be unwise to ignore them.
Our examination of Hume Cement Industries Berhad has focussed on certain factors that can make its earnings look better than they are. 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.