Should You Use Arich Enterprise's (GTSM:4173) Statutory Earnings To Analyse It?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Arich Enterprise (GTSM:4173).

It's good to see that over the last twelve months Arich Enterprise made a profit of NT$54.5m on revenue of NT$1.24b. The chart below shows that revenue has been pretty flat over the last three years, but profit has increased.

See our latest analysis for Arich Enterprise

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, we'll today take a look at how dilution and cashflow shape our understanding of Arich Enterprise's earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Arich Enterprise.

Examining Cashflow Against Arich Enterprise's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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 September 2020, Arich Enterprise had an accrual ratio of -0.36. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$751m in the last year, which was a lot more than its statutory profit of NT$54.5m. Arich Enterprise's free cash flow improved over the last year, which is generally good to see. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Arich Enterprise issued 67% more new shares over the last year. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Arich Enterprise's EPS by clicking here.

How Is Dilution Impacting Arich Enterprise's Earnings Per Share? (EPS)

As you can see above, Arich Enterprise has been growing its net income over the last few years, with an annualized gain of 630% over three years. But EPS was only up 462% per year, in the exact same period. However, net income was pretty flat over the last year with a miniscule decrease. Meanwhile, EPS was actually down a full 24% over the period, highlighting just how different the profits look from a per-share perspective. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Arich Enterprise's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Arich Enterprise's Profit Performance

In conclusion, Arich Enterprise has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Based on these factors, it's hard to tell if Arich Enterprise's profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into Arich Enterprise, you'd also look into what risks it is currently facing. Be aware that Arich Enterprise is showing 3 warning signs in our investment analysis and 1 of those doesn't sit too well with us...

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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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