Is There More To The Story Than Welgene BiotechLtd's (GTSM:6661) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. This article will consider whether Welgene BiotechLtd's (GTSM:6661) statutory profits are a good guide to its underlying earnings.

While Welgene BiotechLtd was able to generate revenue of NT$370.4m in the last twelve months, we think its profit result of NT$34.2m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Welgene BiotechLtd

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. Today, we'll discuss Welgene BiotechLtd'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 Welgene BiotechLtd.

Examining Cashflow Against Welgene BiotechLtd'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. 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. 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. 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.

Welgene BiotechLtd has an accrual ratio of -0.36 for the year to June 2019. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$67m, well over the NT$34.2m it reported in profit. Welgene BiotechLtd's free cash flow improved over the last year, which is generally good to see.

Our Take On Welgene BiotechLtd's Profit Performance

Happily for shareholders, Welgene BiotechLtd produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Welgene BiotechLtd's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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. While earnings are important, another area to consider is the balance sheet. You can seeour latest analysis on Welgene BiotechLtd's balance sheet health here.

Today we've zoomed in on a single data point to better understand the nature of Welgene BiotechLtd'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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.