Niche-Tech Semiconductor Materials' (HKG:8490) Shareholders May Want To Dig Deeper Than Statutory Profit

The recent earnings posted by Niche-Tech Semiconductor Materials Limited (HKG:8490) were solid, but the stock didn't move as much as we expected. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

See our latest analysis for Niche-Tech Semiconductor Materials

Zooming In On Niche-Tech Semiconductor Materials' 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. 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. 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".

Niche-Tech Semiconductor Materials has an accrual ratio of 0.35 for the year to December 2022. 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. In the last twelve months it actually had negative free cash flow, with an outflow of HK$72m despite its profit of HK$8.64m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$72m, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Niche-Tech Semiconductor Materials.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Niche-Tech Semiconductor Materials' profit was boosted by unusual items worth HK$1.7m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. If Niche-Tech Semiconductor Materials doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Niche-Tech Semiconductor Materials' Profit Performance

Summing up, Niche-Tech Semiconductor Materials received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Niche-Tech Semiconductor Materials' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Niche-Tech Semiconductor Materials as a business, it's important to be aware of any risks it's facing. Our analysis shows 2 warning signs for Niche-Tech Semiconductor Materials (1 is potentially serious!) and we strongly recommend you look at these before investing.

Our examination of Niche-Tech Semiconductor Materials 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 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. 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.