We Think Rexon IndustrialLtd's (TPE:1515) Statutory Profit Might Understate Its Earnings Potential

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Rexon IndustrialLtd (TPE:1515).

It's good to see that over the last twelve months Rexon IndustrialLtd made a profit of NT$655.6m on revenue of NT$8.96b. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Rexon IndustrialLtd

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Rexon IndustrialLtd'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 Rexon IndustrialLtd.

Zooming In On Rexon IndustrialLtd'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Rexon IndustrialLtd has an accrual ratio of -0.25 for the year to September 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$1.3b in the last year, which was a lot more than its statutory profit of NT$655.6m. Rexon IndustrialLtd's free cash flow improved over the last year, which is generally good to see.

Our Take On Rexon IndustrialLtd's Profit Performance

Happily for shareholders, Rexon IndustrialLtd produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Rexon IndustrialLtd'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 an extremely impressive rate over the last three years. 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. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. You can see our latest analysis on Rexon IndustrialLtd's balance sheet health here.

This note has only looked at a single factor that sheds light on the nature of Rexon IndustrialLtd's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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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