Should You Use Strong H Machinery Technology (Cayman) Incorporation's (TPE:4560) Statutory Earnings To Analyse It?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Strong H Machinery Technology (Cayman) Incorporation (TPE:4560).

It's good to see that over the last twelve months Strong H Machinery Technology (Cayman) Incorporation made a profit of NT$141.7m on revenue of NT$1.17b. The chart below shows that both revenue and profit have declined over the last three years.

Check out our latest analysis for Strong H Machinery Technology (Cayman) Incorporation

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 Strong H Machinery Technology (Cayman) Incorporation'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 Strong H Machinery Technology (Cayman) Incorporation.

A Closer Look At Strong H Machinery Technology (Cayman) Incorporation'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, Strong H Machinery Technology (Cayman) Incorporation had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$311m, well over the NT$141.7m it reported in profit. Strong H Machinery Technology (Cayman) Incorporation's free cash flow improved over the last year, which is generally good to see.

Our Take On Strong H Machinery Technology (Cayman) Incorporation's Profit Performance

As we discussed above, Strong H Machinery Technology (Cayman) Incorporation has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Strong H Machinery Technology (Cayman) Incorporation's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Every company has risks, and we've spotted 1 warning sign for Strong H Machinery Technology (Cayman) Incorporation you should know about.

This note has only looked at a single factor that sheds light on the nature of Strong H Machinery Technology (Cayman) Incorporation'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. 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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