Here's Why Desiccant Technology's (GTSM:5292) Statutory Earnings Are Arguably Too Conservative

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Desiccant Technology (GTSM:5292).

It's good to see that over the last twelve months Desiccant Technology made a profit of NT$73.6m on revenue of NT$1.11b. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its revenue has slipped in the last twelve months.

View our latest analysis for Desiccant Technology

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 Desiccant Technology's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Desiccant Technology.

Zooming In On Desiccant Technology's 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 June 2020, Desiccant Technology had an accrual ratio of -0.62. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$209m, well over the NT$73.6m it reported in profit. Notably, Desiccant Technology had negative free cash flow last year, so the NT$209m it produced this year was a welcome improvement.

Our Take On Desiccant Technology's Profit Performance

Happily for shareholders, Desiccant Technology produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Desiccant Technology's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 68% 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Desiccant Technology has 2 warning signs we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Desiccant Technology's profit. But there are plenty of other ways to inform your opinion of a company. 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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