Should You Use Yi Shin Textile Industrial's (GTSM:4440) Statutory Earnings To Analyse It?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Yi Shin Textile Industrial (GTSM:4440).

While Yi Shin Textile Industrial was able to generate revenue of NT$1.26b in the last twelve months, we think its profit result of NT$115.9m was more important. Below, you can see that both its revenue and its profit have fallen over the last three years.

See our latest analysis for Yi Shin Textile Industrial

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. Today, we'll discuss Yi Shin Textile Industrial's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Yi Shin Textile Industrial.

Examining Cashflow Against Yi Shin Textile Industrial's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

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. 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 June 2020, Yi Shin Textile Industrial had an accrual ratio of -0.16. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of NT$358m during the period, dwarfing its reported profit of NT$115.9m. Yi Shin Textile Industrial's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On Yi Shin Textile Industrial's Profit Performance

As we discussed above, Yi Shin Textile Industrial has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Yi Shin Textile Industrial's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 3 warning signs for Yi Shin Textile Industrial (of which 1 is concerning!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Yi Shin Textile Industrial'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. 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 that insiders are buying to be useful.

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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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