Here's Why We Think Chang Jia M&E Engineering's (GTSM:4550) Statutory Earnings Might Be Conservative

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Chang Jia M&E Engineering (GTSM:4550).

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. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.

See our latest analysis for Chang Jia M&E Engineering

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. 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.

Examining Cashflow Against 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. 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'.

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.

For the year to September 2020, Chang Jia M&E Engineering had an accrual ratio of -0.21. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of NT$155m, well over the NT$50.9m it reported in profit. Chang Jia M&E Engineering's free cash flow improved over the last year, which is generally good to see.

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

As we discussed above, Chang Jia M&E Engineering's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Chang Jia M&E Engineering's statutory profit actually understates its earnings potential! And the EPS is up 66% annually, over the last three years. 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 Chang Jia M&E Engineering as a business, it's important to be aware of any risks it's facing. For example - Chang Jia M&E Engineering has 3 warning signs we think you should be aware of.

This note has only looked at a single factor that sheds light on 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. 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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