Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. In this article, we’ll look at how useful this year’s statutory profit is, when analysing East Tender Optoelectronics (GTSM:6588).
It’s good to see that over the last twelve months East Tender Optoelectronics made a profit of NT$56.9m on revenue of NT$337.9m. The chart below shows that both revenue and profit have declined over the last three years.
See our latest analysis for East Tender Optoelectronics
Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it’s well worth considering what East Tender Optoelectronics’s cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of East Tender Optoelectronics.
Examining Cashflow Against East Tender Optoelectronics’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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that 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. While it’s not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
East Tender Optoelectronics has an accrual ratio of -0.14 for the year to March 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$119m during the period, dwarfing its reported profit of NT$56.9m. East Tender Optoelectronics shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On East Tender Optoelectronics’s Profit Performance
East Tender Optoelectronics’s accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that East Tender Optoelectronics’s statutory profit actually understates its earnings potential! And the EPS is up 46% over the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company’s potential, but there is plenty more to consider. If you want to do dive deeper into East Tender Optoelectronics, you’d also look into what risks it is currently facing. Our analysis shows 3 warning signs for East Tender Optoelectronics (1 can’t be ignored!) and we strongly recommend you look at these before investing.
This note has only looked at a single factor that sheds light on the nature of East Tender Optoelectronics’s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.