Does Hong Yi Fiber Ind's (TPE:1452) Statutory Profit Adequately Reflect Its Underlying Profit?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Hong Yi Fiber Ind's (TPE:1452) statutory profits are a good guide to its underlying earnings.

While Hong Yi Fiber Ind was able to generate revenue of NT$1.28b in the last twelve months, we think its profit result of NT$71.3m 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 Hong Yi Fiber Ind

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, today we're going to take a closer look at Hong Yi Fiber Ind's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hong Yi Fiber Ind.

A Closer Look At Hong Yi Fiber Ind'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Hong Yi Fiber Ind recorded an accrual ratio of -0.13. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of NT$240m during the period, dwarfing its reported profit of NT$71.3m. Hong Yi Fiber Ind's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

The Impact Of Unusual Items On Profit

Surprisingly, given Hong Yi Fiber Ind's accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$5.5m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Hong Yi Fiber Ind's Profit Performance

Hong Yi Fiber Ind's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if Hong Yi Fiber Ind's profits are a reasonable reflection of its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 4 warning signs for Hong Yi Fiber Ind you should be mindful of and 1 of these bad boys is significant.

Our examination of Hong Yi Fiber Ind has focussed on certain factors that can make its earnings look better than they are. 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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