Are Song Ho Industrial's (GTSM:5016) Statutory Earnings A Good Guide To Its Underlying Profitability?

Broadly speaking, profitable businesses are less risky than 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Song Ho Industrial (GTSM:5016).

It's good to see that over the last twelve months Song Ho Industrial made a profit of NT$152.0m on revenue of NT$2.35b. Below, you can see that both its revenue and its profit have fallen over the last three years.

Check out our latest analysis for Song Ho Industrial

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 think it's well worth considering what Song Ho 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 Song Ho Industrial.

Examining Cashflow Against Song Ho 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). 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. 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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2020, Song Ho Industrial recorded an accrual ratio of -0.11. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. Indeed, in the last twelve months it reported free cash flow of NT$352m, well over the NT$152.0m it reported in profit. Song Ho Industrial shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Song Ho Industrial's Profit Performance

As we discussed above, Song Ho Industrial has perfectly satisfactory free cash flow relative to profit. Because of this, we think Song Ho Industrial's earnings potential is at least as good as it seems, and maybe even better! And the EPS is up 76% over 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 Song Ho Industrial, you'd also look into what risks it is currently facing. For instance, we've identified 4 warning signs for Song Ho Industrial (1 is a bit unpleasant) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Song Ho 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.

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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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