Trek 2000 International's (SGX:5AB) Earnings Seem To Be Promising

Trek 2000 International Ltd (SGX:5AB) announced a healthy earnings result recently, and the market rewarded it with a strong uplift in the stock price. According to our analysis of the report, the strong headline profit numbers are supported by strong earnings fundamentals.

Check out our latest analysis for Trek 2000 International

Zooming In On Trek 2000 International'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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Trek 2000 International recorded an accrual ratio of -0.31. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$2.8m, well over the US$1.48m it reported in profit. Notably, Trek 2000 International had negative free cash flow last year, so the US$2.8m it produced this year was a welcome improvement. 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 Trek 2000 International.

How Do Unusual Items Influence Profit?

Surprisingly, given Trek 2000 International's accrual ratio implied strong cash conversion, its paper profit was actually boosted by US$542k in 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. If Trek 2000 International 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 Trek 2000 International's Profit Performance

Trek 2000 International's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, we think that Trek 2000 International's profits are a reasonably conservative guide to its underlying profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Trek 2000 International is showing 3 warning signs in our investment analysis and 1 of those is concerning...

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.