Holdings (OB:CRAYN) Earnings Are Of Questionable Quality

Crayon Group Holding ASA's (OB:CRAYN) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.
Examining Cashflow Against Crayon Group Holding'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 December 2020, Crayon Group Holding recorded an accrual ratio of -1.90. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of kr860m, well over the kr120.5m it reported in profit. Crayon Group Holding shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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. Crayon Group Holding expanded the number of shares on issue by 8.7% over the last year. As a result, its net income is now split between a greater number of shares. 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 Crayon Group Holding's EPS by clicking here.

How Is Dilution Impacting Crayon Group Holding's Earnings Per Share? (EPS)
Three years ago, Crayon Group Holding lost money. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). And so, you can see quite clearly that dilution is influencing shareholder earnings.

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In the long term, if Crayon Group Holding's 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 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.

How Do Unusual Items Influence Profit?
While the accrual ratio might bode well, we also note that Crayon Group Holding's profit was boosted by unusual items worth kr17m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

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Our Take On Crayon Group Holding's Profit Performance
Summing up, Crayon Group Holding's accrual ratio suggests that its statutory earnings are well matched by cash flow while its unusual items boosted the profit in a way that might not be repeated. Further, the dilution means profits are now split more ways. Based on these factors, it's hard to tell if Crayon Group Holding's profits are a reasonable reflection of its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing Crayon Group Holding at this point in time. For example - Crayon Group Holding has 2 warning signs we think you should be aware of.

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In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying.

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