Tofu Restaurant's (GTSM:2752) Earnings Are Growing But Is There More To The Story?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Tofu Restaurant's (GTSM:2752) statutory profits are a good guide to its underlying earnings.

We like the fact that Tofu Restaurant made a profit of NT$205.0m on its revenue of NT$1.67b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

View our latest analysis for Tofu Restaurant

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. So today we'll look at what Tofu Restaurant's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tofu Restaurant.

A Closer Look At Tofu Restaurant'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Tofu Restaurant has an accrual ratio of -0.25 for the year to September 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$228m in the last year, which was a lot more than its statutory profit of NT$205.0m. Tofu Restaurant shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Tofu Restaurant's Profit Performance

As we discussed above, Tofu Restaurant's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Tofu Restaurant's statutory profit actually understates its earnings potential! And the EPS is up 49% annually, over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Tofu Restaurant, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Tofu Restaurant, and understanding it should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Tofu Restaurant's 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. 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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