Should You Use Tah Kong Chemical Industrial's (GTSM:4706) Statutory Earnings To Analyse It?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Tah Kong Chemical Industrial (GTSM:4706).

While Tah Kong Chemical Industrial was able to generate revenue of NT$1.29b in the last twelve months, we think its profit result of NT$78.3m was more important. The chart below shows that both revenue and profit have declined over the last three years.

View our latest analysis for Tah Kong Chemical Industrial

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. As a result, we think it's well worth considering what Tah Kong Chemical Industrial's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tah Kong Chemical Industrial.

Examining Cashflow Against Tah Kong Chemical Industrial's 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.

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. 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 September 2020, Tah Kong Chemical Industrial had an accrual ratio of -0.17. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$241m during the period, dwarfing its reported profit of NT$78.3m. Over the last year, Tah Kong Chemical Industrial's free cash flow remained steady.

Our Take On Tah Kong Chemical Industrial's Profit Performance

Happily for shareholders, Tah Kong Chemical Industrial produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Tah Kong Chemical Industrial's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you want to do dive deeper into Tah Kong Chemical Industrial, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Tah Kong Chemical Industrial (1 is concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Tah Kong Chemical Industrial's profit. But there are plenty of other ways to inform your opinion of a company. 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 that insiders are buying to be useful.

If you’re looking to trade Tah Kong Chemical Industrial, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.