Should You Use Hotron Precision Electronic IndustrialLtd's (GTSM:3092) Statutory Earnings To Analyse It?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Hotron Precision Electronic IndustrialLtd's (GTSM:3092) statutory profits are a good guide to its underlying earnings.

We like the fact that Hotron Precision Electronic IndustrialLtd made a profit of NT$225.7m on its revenue of NT$2.80b, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

View our latest analysis for Hotron Precision Electronic IndustrialLtd

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Hotron Precision Electronic IndustrialLtd's cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Zooming In On Hotron Precision Electronic IndustrialLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 September 2020, Hotron Precision Electronic IndustrialLtd recorded an accrual ratio of -0.11. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of NT$429m in the last year, which was a lot more than its statutory profit of NT$225.7m. Hotron Precision Electronic IndustrialLtd's free cash flow improved over the last year, which is generally good to see.

Our Take On Hotron Precision Electronic IndustrialLtd's Profit Performance

As we discussed above, Hotron Precision Electronic IndustrialLtd has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Hotron Precision Electronic IndustrialLtd's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Hotron Precision Electronic IndustrialLtd as a business, it's important to be aware of any risks it's facing. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Hotron Precision Electronic IndustrialLtd.

This note has only looked at a single factor that sheds light on the nature of Hotron Precision Electronic IndustrialLtd'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. 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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