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. This article will consider whether RISE's (TYO:8836) statutory profits are a good guide to its underlying earnings.
We like the fact that RISE made a profit of JP¥144.0m on its revenue of JP¥398.0m, in the last year. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.
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 reuslt, we think it's important to consider how unusual items and the recent tax benefit have influenced RISE's statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of RISE.
The Impact Of Unusual Items On Profit
To properly understand RISE's profit results, we need to consider the JP¥128m gain attributed to unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. RISE had a rather significant contribution from unusual items relative to its profit to September 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
An Unusual Tax Situation
Having already discussed the impact of the unusual items, we should also note that RISE received a tax benefit of JP¥15m. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! The receipt of a tax benefit is obviously a good thing, on its own. And given that it lost money last year, it seems possible that the benefit is evidence that it now expects to find value in its past tax losses. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal. While we think it's good that the company has booked a tax benefit, it does mean that there's every chance the statutory profit will come in a lot higher than it would be if the income was adjusted for one-off factors.
Our Take On RISE's Profit Performance
In the last year RISE received a tax benefit, which boosted its profit in a way that might not be much more sustainable than turning prime farmland into gas fields. Furthermore, it also benefitted from a positive unusual item, which boosted the profit result even higher. Considering all this we'd argue RISE's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing RISE at this point in time. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of RISE.
In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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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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