Shareholders Can Be Confident That Action Electronics' (TWSE:3024) Earnings Are High Quality

Even though Action Electronics Co., Ltd. (TWSE:3024 ) posted strong earnings, investors appeared to be underwhelmed. Our analysis says that investors should be optimistic, as the strong profit is built on solid foundations.

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Examining Cashflow Against Action Electronics' 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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2024, Action Electronics had an accrual ratio of -0.24. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$868m in the last year, which was a lot more than its statutory profit of NT$183.7m. Notably, Action Electronics had negative free cash flow last year, so the NT$868m it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Action Electronics.

Our Take On Action Electronics' Profit Performance

As we discussed above, Action Electronics' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Action Electronics' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. You can see our latest analysis on Action Electronics' balance sheet health here.

Today we've zoomed in on a single data point to better understand the nature of Action Electronics' profit. 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. 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.