Chung Hung Steel's (TPE:2014) Solid Earnings Have Been Accounted For Conservatively

The market seemed underwhelmed by the solid earnings posted by Chung Hung Steel Corporation (TPE:2014) recently. Along with the solid headline numbers, we think that investors have some reasons for optimism.

Check out our latest analysis for Chung Hung Steel

A Closer Look At Chung Hung Steel'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Chung Hung Steel has an accrual ratio of -0.15 for the year to December 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of NT$4.3b in the last year, which was a lot more than its statutory profit of NT$528.3m. Chung Hung Steel shareholders are no doubt pleased that free cash flow improved over the last twelve months.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Chung Hung Steel's Profit Performance

As we discussed above, Chung Hung Steel has perfectly satisfactory free cash flow relative to profit. Because of this, we think Chung Hung Steel's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. 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. 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. You'd be interested to know, that we found 2 warning signs for Chung Hung Steel and you'll want to know about them.

This note has only looked at a single factor that sheds light on the nature of Chung Hung Steel's 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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