DIT Group Limited's (HKG:726) stock showed strength after its weak earnings report. We think that shareholders might be missing some concerning factors that our analysis found.

View our latest analysis for DIT Group

A Closer Look At DIT Group's Earnings

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. 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'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2021, DIT Group had an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of HK$808m despite its profit of HK$132.4m, mentioned above. We also note that DIT Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$808m. 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 DIT Group.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, DIT Group increased the number of shares on issue by 11% 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 talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of DIT Group's EPS by clicking here.

How Is Dilution Impacting DIT Group's Earnings Per Share? (EPS)

As you can see above, DIT Group has been growing its net income over the last few years, with an annualized gain of 386% over three years. Net income was down 17% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 18%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If DIT Group's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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 DIT Group's Profit Performance

In conclusion, DIT Group has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). Considering all this we'd argue DIT Group's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about DIT Group as a business, it's important to be aware of any risks it's facing. For instance, we've identified 5 warning signs for DIT Group (2 make us uncomfortable) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.