Here's Why Cincon Electronics's (GTSM:3332) Statutory Earnings Are Arguably Too Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Cincon Electronics (GTSM:3332).

It's good to see that over the last twelve months Cincon Electronics made a profit of NT$104.5m on revenue of NT$1.05b. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

View our latest analysis for Cincon Electronics

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 result, we think it's well worth considering what Cincon Electronics' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Cincon Electronics.

A Closer Look At Cincon Electronics' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2020, Cincon Electronics had an accrual ratio of -0.26. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$232m during the period, dwarfing its reported profit of NT$104.5m. Cincon Electronics did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

Our Take On Cincon Electronics' Profit Performance

As we discussed above, Cincon Electronics' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Cincon Electronics' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 3 warning signs for Cincon Electronics (of which 1 can't be ignored!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Cincon Electronics' profit. 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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