The Strong Earnings Posted By Chien Kuo Construction (TWSE:5515) Are A Good Indication Of The Strength Of The Business

When companies post strong earnings, the stock generally performs well, just like Chien Kuo Construction Co., Ltd.'s (TWSE:5515) stock has recently. We did some digging and found some further encouraging factors that investors will like.

See our latest analysis for Chien Kuo Construction

Zooming In On Chien Kuo Construction's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 2024, Chien Kuo Construction had an accrual ratio of -0.92. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$950m during the period, dwarfing its reported profit of NT$570.1m. Chien Kuo Construction's free cash flow improved over the last year, which is generally good to see. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chien Kuo Construction.

The Impact Of Unusual Items On Profit

Surprisingly, given Chien Kuo Construction's accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$72m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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'. Chien Kuo Construction had a rather significant contribution from unusual items relative to its profit to September 2024. 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 Chien Kuo Construction's Profit Performance

In conclusion, Chien Kuo Construction's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don't have a strong view as to whether Chien Kuo Construction's profits are an apt reflection of its underlying potential for profit. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Chien Kuo Construction.

Our examination of Chien Kuo Construction 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. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.