Lungteh Shipbuilding's (GTSM:6753) Solid Earnings May Rest On Weak Foundations

Lungteh Shipbuilding Co., Ltd.'s (GTSM:6753) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

View our latest analysis for Lungteh Shipbuilding

Examining Cashflow Against Lungteh Shipbuilding'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2020, Lungteh Shipbuilding recorded an accrual ratio of 0.53. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of NT$143.5m, a look at free cash flow indicates it actually burnt through NT$882m in the last year. We also note that Lungteh Shipbuilding's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$882m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lungteh Shipbuilding.

Our Take On Lungteh Shipbuilding's Profit Performance

As we discussed above, we think Lungteh Shipbuilding's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Lungteh Shipbuilding's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. And we are pleased to note that EPS is at least heading in the right direction in the alst twelve months. 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. Our analysis shows 3 warning signs for Lungteh Shipbuilding (2 are a bit unpleasant!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Lungteh Shipbuilding'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. 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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