Triocean Industrial Corporation's (TWSE:1472) Earnings Are Of Questionable Quality

Despite posting some strong earnings, the market for Triocean Industrial Corporation Co., Ltd.'s (TWSE:1472) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

Check out our latest analysis for Triocean Industrial Corporation

Examining Cashflow Against Triocean Industrial Corporation'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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Triocean Industrial Corporation recorded an accrual ratio of -0.44. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of NT$511m, well over the NT$133.7m it reported in profit. Triocean Industrial Corporation shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Triocean Industrial Corporation.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Triocean Industrial Corporation issued 24% more new shares over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Triocean Industrial Corporation's historical EPS growth by clicking on this link.

How Is Dilution Impacting Triocean Industrial Corporation's Earnings Per Share (EPS)?

Triocean Industrial Corporation was losing money three years ago. The good news is that profit was up 37% in the last twelve months. But EPS was far less impressive, dropping 11% in that time. This is a great example of why it's rather imprudent to rely only on net income as a growth measure. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Triocean Industrial Corporation's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Surprisingly, given Triocean Industrial Corporation's accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$19m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Triocean Industrial Corporation doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Triocean Industrial Corporation's Profit Performance

Summing up, Triocean Industrial Corporation's accrual ratio suggests that its statutory earnings are well matched by cash flow while its unusual items boosted the profit in a way that might not be repeated. Meanwhile, the dilution was a negative for shareholders. Based on these factors, we think it's very unlikely that Triocean Industrial Corporation's statutory profits make it seem much weaker than it is. If you want to do dive deeper into Triocean Industrial Corporation, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Triocean Industrial Corporation you should be aware of.

Our examination of Triocean Industrial Corporation has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.