Are Shuz Tung Machinery Industrial's (GTSM:4537) Statutory Earnings A Good Guide To Its Underlying Profitability?

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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 Shuz Tung Machinery Industrial (GTSM:4537).

While Shuz Tung Machinery Industrial was able to generate revenue of NT$2.72b in the last twelve months, we think its profit result of NT$123.3m was more important. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.

View our latest analysis for Shuz Tung Machinery Industrial

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Shuz Tung Machinery Industrial's cashflow tells us about its earnings, as well as examining how the receipt of a tax benefit has impacted its statutory earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shuz Tung Machinery Industrial.

Examining Cashflow Against Shuz Tung Machinery Industrial'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Shuz Tung Machinery Industrial has an accrual ratio of -0.11 for the year to June 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$394m, well over the NT$123.3m it reported in profit. Notably, Shuz Tung Machinery Industrial had negative free cash flow last year, so the NT$394m it produced this year was a welcome improvement. However, as we will discuss below, we can see that the company's accrual ratio has been impacted by its tax situation.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Shuz Tung Machinery Industrial received a tax benefit of NT$16m. This is meaningful because companies usually pay tax rather than receive tax benefits. We're sure the company was pleased with its tax benefit. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal.

Our Take On Shuz Tung Machinery Industrial's Profit Performance

In conclusion, Shuz Tung Machinery Industrial has strong cashflow relative to earnings, which indicates good quality earnings, but the tax benefit means its profit wasn't as sustainable as we'd like to see. Based on these factors, it's hard to tell if Shuz Tung Machinery Industrial's profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into Shuz Tung Machinery Industrial, you'd also look into what risks it is currently facing. For example - Shuz Tung Machinery Industrial has 2 warning signs we think you should be aware of.

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 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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