Are I-Sheng Electric Wire & Cable's (TPE:6115) Statutory Earnings A Good Guide To Its Underlying Profitability?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing I-Sheng Electric Wire & Cable (TPE:6115).

While I-Sheng Electric Wire & Cable was able to generate revenue of NT$6.10b in the last twelve months, we think its profit result of NT$444.8m was more important. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

See our latest analysis for I-Sheng Electric Wire & Cable

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what I-Sheng Electric Wire & Cable'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 I-Sheng Electric Wire & Cable.

Examining Cashflow Against I-Sheng Electric Wire & Cable'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

I-Sheng Electric Wire & Cable has an accrual ratio of -0.17 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$958m in the last year, which was a lot more than its statutory profit of NT$444.8m. I-Sheng Electric Wire & Cable shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On I-Sheng Electric Wire & Cable's Profit Performance

Happily for shareholders, I-Sheng Electric Wire & Cable produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that I-Sheng Electric Wire & Cable'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. If you want to do dive deeper into I-Sheng Electric Wire & Cable, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for I-Sheng Electric Wire & Cable (1 makes us a bit uncomfortable!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of I-Sheng Electric Wire & Cable's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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