XL Holdings Berhad's (KLSE:XL) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

See our latest analysis for XL Holdings Berhad

Zooming In On XL Holdings Berhad's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

XL Holdings Berhad has an accrual ratio of 0.24 for the year to July 2024. 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 RM30m despite its profit of RM9.29m, mentioned above. We also note that XL Holdings Berhad's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM30m. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 XL Holdings Berhad.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, XL Holdings Berhad increased the number of shares on issue by 26% 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 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. Check out XL Holdings Berhad's historical EPS growth by clicking on this link.

A Look At The Impact Of XL Holdings Berhad's Dilution On Its Earnings Per Share (EPS)

XL Holdings Berhad has improved its profit over the last three years, with an annualized gain of 22,833% in that time. But EPS was only up 7,396% per year, in the exact same period. And the 39% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 28% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So XL Holdings Berhad shareholders will want to see that EPS figure continue to increase. 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.

Our Take On XL Holdings Berhad's Profit Performance

As it turns out, XL Holdings Berhad couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue XL Holdings Berhad's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into XL Holdings Berhad, you'd also look into what risks it is currently facing. For example, we've found that XL Holdings Berhad has 3 warning signs (1 is concerning!) that deserve your attention before going any further with your analysis.

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 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 with high insider ownership.

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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.