JG Environmental TechnologyLtd's (GTSM:6723) Earnings Are Growing But Is There More To The Story?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. This article will consider whether JG Environmental TechnologyLtd's (GTSM:6723) statutory profits are a good guide to its underlying earnings.

We like the fact that JG Environmental TechnologyLtd made a profit of NT$50.1m on its revenue of NT$1.02b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for JG Environmental TechnologyLtd

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. So today we'll look at what JG Environmental TechnologyLtd'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 JG Environmental TechnologyLtd.

Zooming In On JG Environmental TechnologyLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2020, JG Environmental TechnologyLtd had an accrual ratio of 0.52. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of NT$50.1m, a look at free cash flow indicates it actually burnt through NT$91m in the last year. We saw that FCF was NT$64m a year ago though, so JG Environmental TechnologyLtd has at least been able to generate positive FCF in the past. The good news for shareholders is that JG Environmental TechnologyLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On JG Environmental TechnologyLtd's Profit Performance

As we discussed above, we think JG Environmental TechnologyLtd's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that JG Environmental TechnologyLtd's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 62% per annum growth in EPS for the last three. 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. So while earnings quality is important, it's equally important to consider the risks facing JG Environmental TechnologyLtd at this point in time. Case in point: We've spotted 4 warning signs for JG Environmental TechnologyLtd you should be mindful of and 2 of them are concerning.

Today we've zoomed in on a single data point to better understand the nature of JG Environmental TechnologyLtd'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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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