Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether STL Technology’s (GTSM:4931) statutory profits are a good guide to its underlying earnings.
While STL Technology was able to generate revenue of NT$1.79b in the last twelve months, we think its profit result of NT$115.1m was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its revenue is down over the last year).
Check out our latest analysis for STL Technology
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. So today we’ll examine what STL Technology’s cashflow and its expanding share count tell us about the nature of its profits. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of STL Technology.
Examining Cashflow Against STL Technology’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. This ratio tells us how much of a company’s profit is not backed by free cashflow.
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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to June 2020, STL Technology had an accrual ratio of -0.33. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of NT$188m during the period, dwarfing its reported profit of NT$115.1m. STL Technology’s free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.
In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, STL Technology issued 13% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of STL Technology’s EPS by clicking here.
How Is Dilution Impacting STL Technology’s Earnings Per Share? (EPS)
As you can see above, STL Technology has been growing its net income over the last few years, with an annualized gain of 306% over three years. But EPS was only up 263% per year, in the exact same period. And in the last year the company managed to bump profit up by 12%. Meanwhile, EPS was flat over the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.
In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if STL Technology can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical “share” of the company’s profit.
Our Take On STL Technology’s Profit Performance
In conclusion, STL Technology has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Based on these factors, we think that STL Technology’s profits are a reasonably conservative guide to its underlying profitability. With this in mind, we wouldn’t consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we’ve spotted 4 warning signs for STL Technology you should know about.
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 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. 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.
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