Statistically speaking, it is less risky to invest in profitable companies than in 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. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding Yeh-Chiang Technology (GTSM:6124).
It’s good to see that over the last twelve months Yeh-Chiang Technology made a profit of NT$167.2m on revenue of NT$2.27b.
See our latest analysis for Yeh-Chiang Technology
Importantly, statutory profits are not always the best tool for understanding a company’s true earnings power, so it’s well worth examining profits in a little more detail. Today, we’ll discuss Yeh-Chiang Technology’s free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Yeh-Chiang Technology.
Zooming In On Yeh-Chiang Technology’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. 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.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Yeh-Chiang Technology has an accrual ratio of 0.29 for the year to March 2020. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of NT$167.2m, a look at free cash flow indicates it actually burnt through NT$387.5m in the last year. We also note that Yeh-Chiang Technology’s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$387.5m.
Our Take On Yeh-Chiang Technology’s Profit Performance
Yeh-Chiang Technology’s accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Yeh-Chiang Technology’s true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. Of course, we’ve only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it’s equally important to consider the risks facing Yeh-Chiang Technology at this point in time. For example, we’ve found that Yeh-Chiang Technology has 2 warning signs (1 shouldn’t be ignored!) that deserve your attention before going any further with your analysis.
This note has only looked at a single factor that sheds light on the nature of Yeh-Chiang Technology’s profit. 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. 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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