Should You Rely On Run Long ConstructionLtd's (TPE:1808) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Run Long ConstructionLtd (TPE:1808).

It's good to see that over the last twelve months Run Long ConstructionLtd made a profit of NT$843.1m on revenue of NT$6.77b. One positive is that it has grown both its profit and its revenue, over the last few years.

View our latest analysis for Run Long ConstructionLtd

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. As a result, today we're going to take a closer look at Run Long ConstructionLtd's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Run Long ConstructionLtd.

Zooming In On Run Long ConstructionLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Run Long ConstructionLtd has an accrual ratio of 0.26 for the year to September 2020. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of NT$4.9b despite its profit of NT$843.1m, mentioned above. We also note that Run Long ConstructionLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$4.9b. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Run Long ConstructionLtd's profit was boosted by unusual items worth NT$898m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Run Long ConstructionLtd's positive unusual items were quite significant relative to its profit in the year to September 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Run Long ConstructionLtd's Profit Performance

Run Long ConstructionLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Run Long ConstructionLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Run Long ConstructionLtd as a business, it's important to be aware of any risks it's facing. For example - Run Long ConstructionLtd has 3 warning signs we think you should be aware of.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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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