Are Kung Long Batteries IndustrialLtd's (TPE:1537) Statutory Earnings A Good Guide To Its Underlying Profitability?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Kung Long Batteries IndustrialLtd's (TPE:1537) statutory profits are a good guide to its underlying earnings.

We like the fact that Kung Long Batteries IndustrialLtd made a profit of NT$887.4m on its revenue of NT$7.22b, in the last year. Below, you can see that both its revenue and its profit have fallen over the last three years.

View our latest analysis for Kung Long Batteries IndustrialLtd

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 Kung Long Batteries 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 Kung Long Batteries IndustrialLtd.

A Closer Look At Kung Long Batteries IndustrialLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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.

Over the twelve months to September 2020, Kung Long Batteries IndustrialLtd recorded an accrual ratio of -0.16. 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$887.4m. Kung Long Batteries IndustrialLtd did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

Our Take On Kung Long Batteries IndustrialLtd's Profit Performance

Happily for shareholders, Kung Long Batteries IndustrialLtd produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Kung Long Batteries IndustrialLtd's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last 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. If you want to do dive deeper into Kung Long Batteries IndustrialLtd, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 1 warning sign for Kung Long Batteries IndustrialLtd you should know about.

This note has only looked at a single factor that sheds light on the nature of Kung Long Batteries IndustrialLtd'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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