Should You Rely On Dynamic Medical Technologies's (GTSM:4138) Earnings Growth?

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 Dynamic Medical Technologies' (GTSM:4138) statutory profits are a good guide to its underlying earnings.

We like the fact that Dynamic Medical Technologies made a profit of NT$120.0m on its revenue of NT$1.04b, in the last year. Even though its revenue is down over the last three years, its profit has actually increased, as you can see, below.

See our latest analysis for Dynamic Medical Technologies

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss Dynamic Medical Technologies' 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 Dynamic Medical Technologies.

A Closer Look At Dynamic Medical Technologies' 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'.

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".

Dynamic Medical Technologies has an accrual ratio of -0.47 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$274m in the last year, which was a lot more than its statutory profit of NT$120.0m. Dynamic Medical Technologies shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Dynamic Medical Technologies' Profit Performance

Happily for shareholders, Dynamic Medical Technologies produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Dynamic Medical Technologies' 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 7.9% per year over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For instance, we've identified 2 warning signs for Dynamic Medical Technologies (1 is a bit concerning) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Dynamic Medical Technologies' profit. 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 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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