Formosa Prosonic Industries Berhad's (KLSE:FPI) Earnings Are Growing But Is There More To The Story?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Formosa Prosonic Industries Berhad (KLSE:FPI).

It's good to see that over the last twelve months Formosa Prosonic Industries Berhad made a profit of RM48.7m on revenue of RM688.5m. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its revenue has slipped in the last twelve months.

See our latest analysis for Formosa Prosonic Industries Berhad

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 look at what Formosa Prosonic Industries Berhad's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Formosa Prosonic Industries Berhad.

Examining Cashflow Against Formosa Prosonic Industries Berhad's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Formosa Prosonic Industries Berhad recorded an accrual ratio of -0.19. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of RM103m during the period, dwarfing its reported profit of RM48.7m. Formosa Prosonic Industries Berhad shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Formosa Prosonic Industries Berhad's Profit Performance

As we discussed above, Formosa Prosonic Industries Berhad's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Formosa Prosonic Industries Berhad's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 26% per year over the last three years. 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. If you want to do dive deeper into Formosa Prosonic Industries Berhad, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Formosa Prosonic Industries Berhad you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Formosa Prosonic Industries Berhad's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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