The muted market reaction suggests that River Tech plc (OB:RIVER) recent earnings did not contain any surprises. However, we believe investors should be aware of some underlying factors that may be of concern.

See our latest analysis for River Tech

Review of Cash Flow vs. Earnings at River Tech

Many investors have not heard of the cash flow equalization ratio, but it’s actually a useful measure of how well a company’s earnings are supported by free cash flow (FCF) over a given period. To get the strike ratio, we first subtract FCF from earnings 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 cash flow.

Therefore, a negative accrual ratio is positive for the company and a positive accrual ratio is negative. While having a accrual ratio greater than zero is of little concern, we believe it is worth noting when a company has a relatively high accrual ratio. Notably, there is academic evidence that suggests a high exercise ratio is a bad sign for short-term profits, generally speaking.

River Tech has an accrual ratio of -0.80 for the year to December 2021. As a result, its statutory profit was significantly lower than its free cash flow. In fact, it had a free cash flow of 6.3 million euros last year, which was well above its statutory profit of 4.43 million euros. River Tech shareholders are no doubt pleased with the improvement in free cash flow over the past twelve months. That said, there is more to consider. We also need to consider the impact of unusual items on statutory profit (and therefore the accrual rate), as well as note the ramifications of the company issuing new shares.

To note: we always recommend that investors check the strength of the balance sheet. Click here to access our analysis of River Tech’s balance sheet.

To understand the value of a company’s earnings growth, it is imperative to consider any dilution of shareholder interests. River Tech has increased the number of shares issued by 7.5% over the past year. Therefore, each stock now receives a smaller portion of the profits. Celebrating net income while ignoring dilution is like rejoicing that you have a single slice of a bigger pizza, but ignoring the fact that the pizza is now cut into multiple slices. Learn about River Tech’s historic EPS growth by clicking this link.

What is the impact of dilution on River Tech’s earnings per share? (EPS)

River Tech was losing money three years ago. And even just focusing on the last twelve months, we see that profits are down 65%. Unfortunately, the gains per share fell further, down a full 65% in that time. So you can see that the dilution had a bit of an impact on the shareholders.

If River Tech’s EPS can grow over time, that greatly improves the odds that the stock price will move in the same direction. However, if its earnings increase while its earnings per share remain stable (or even decline), shareholders might not see much benefit. For this reason, one could argue that EPS is more important than long-term net income, assuming the goal is to gauge whether a company’s stock price can rise.

The impact of unusual items on earnings

While the accrual rate bodes well, we also note that River Tech’s earnings have been boosted by unusual items worth €501,000 over the past twelve months. While we like to see increases in earnings, we tend to be a bit more cautious when unusual items have made a big contribution. We have analyzed the figures of most publicly traded companies around the world, and it is very common for unusual items to be unique in nature. Which is hardly surprising, given the name. Assuming these unusual items do not recur in the current year, we would therefore expect earnings to be weaker next year (in the absence of business growth, i.e. ).

Our view on River Tech’s earnings performance

In conclusion, River Tech’s accrual ratio suggests its earnings are well supported by cash, but its boost from unusual items is unlikely to repeat consistently. Meanwhile, the dilution has been negative for shareholders. Based on these factors, we think it’s highly unlikely that River Tech’s statutory earnings will make it look much weaker than it is. In light of this, if you want to do more analysis on the company, it is essential to be aware of the risks involved. When we did our research, we found 5 warning signs for River Tech (2 are concerning!) which we believe deserve your full attention.

Our River Tech review has focused on some factors that can make its earnings look better than they are. But there are many other ways to inform your opinion about a company. Some people consider a high return on equity to be a good sign of a quality company. Although it might take a bit of research on your behalf, you might find this free collection of companies offering a high return on equity, or this list of stocks that insiders buy to be useful.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.