Diamondback Energy, Inc. (NASDAQ:FANG) posted some decent earnings, but shareholders didn't react strongly. Our analysis has found some concerning factors which weaken the profit's foundation.

Check out our latest analysis for Diamondback Energy

Examining Cashflow Against Diamondback Energy'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'.

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. 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".

For the year to September 2024, Diamondback Energy had an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of US$3.20b, a look at free cash flow indicates it actually burnt through US$5.7b in the last year. We saw that FCF was US$898m a year ago though, so Diamondback Energy has at least been able to generate positive FCF in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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. Diamondback Energy expanded the number of shares on issue by 63% over the last year. Therefore, each share now receives a smaller portion of profit. 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 Diamondback Energy's EPS by clicking here.

How Is Dilution Impacting Diamondback Energy's Earnings Per Share (EPS)?

Diamondback Energy has improved its profit over the last three years, with an annualized gain of 645% in that time. In comparison, earnings per share only gained 588% over the same period. While we did see a very small increase, net profit was basically flat over the last year. While EPS growth was also pretty flat, but no prizes for guessing that it looked worse than the net income. So you can see that the dilution has had a fairly significant impact on shareholders.

If Diamondback Energy's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Diamondback Energy's Profit Performance

As it turns out, Diamondback Energy couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For the reasons mentioned above, we think that a perfunctory glance at Diamondback Energy's statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 4 warning signs for Diamondback Energy (2 are a bit unpleasant) you should be familiar with.

Our examination of Diamondback Energy has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.