It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. In this article, we'll look at how useful this year's statutory profit is, when analysing Evermore Chemical Industry (TPE:1735).
It's good to see that over the last twelve months Evermore Chemical Industry made a profit of NT$45.3m on revenue of NT$2.46b. The chart below shows that both revenue and profit have declined over the last three years.
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 Evermore Chemical Industry'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 Evermore Chemical Industry.
Examining Cashflow Against Evermore Chemical Industry'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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".
For the year to September 2020, Evermore Chemical Industry had an accrual ratio of -0.14. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of NT$342m in the last year, which was a lot more than its statutory profit of NT$45.3m. Evermore Chemical Industry shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On Evermore Chemical Industry's Profit Performance
Evermore Chemical Industry's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Evermore Chemical Industry's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Our analysis shows 5 warning signs for Evermore Chemical Industry (1 makes us a bit uncomfortable!) and we strongly recommend you look at them before investing.
This note has only looked at a single factor that sheds light on the nature of Evermore Chemical Industry'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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