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Hercules Site Services Plc's (LON:HERC) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.
View our latest analysis for Hercules Site Services
Zooming In On Hercules Site Services' Earnings
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. The ratio shows us how much a company's profit exceeds its FCF.
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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Hercules Site Services has an accrual ratio of -0.30 for the year to September 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of UK£5.7m during the period, dwarfing its reported profit of UK£1.64m. Hercules Site Services shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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. In fact, Hercules Site Services increased the number of shares on issue by 26% over the last twelve months by issuing new shares. 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 Hercules Site Services' EPS by clicking here.
A Look At The Impact Of Hercules Site Services' Dilution On Its Earnings Per Share (EPS)
Hercules Site Services was losing money three years ago. But over the last year profit has held pretty steady. But EPS was considerably worse, since it declined 7.0% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.