Here's Why Chang Jia M&E Engineering's (GTSM:4550) Statutory Earnings Are Arguably Too Conservative

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Chang Jia M&E Engineering's (GTSM:4550) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Chang Jia M&E Engineering made a profit of NT$50.9m on revenue of NT$1.35b. The chart below shows how profit has actually increased over the last three years, even while revenue has declined.

View our latest analysis for Chang Jia M&E Engineering

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what Chang Jia M&E Engineering's 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 Chang Jia M&E Engineering.

Zooming In On Chang Jia M&E Engineering'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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.

Chang Jia M&E Engineering has an accrual ratio of -0.22 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of NT$155m during the period, dwarfing its reported profit of NT$50.9m. Chang Jia M&E Engineering shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Chang Jia M&E Engineering's Profit Performance

Happily for shareholders, Chang Jia M&E Engineering produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Chang Jia M&E Engineering'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 66% per year over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Chang Jia M&E Engineering you should know about.

Today we've zoomed in on a single data point to better understand the nature of Chang Jia M&E Engineering'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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