Are Feng Hsin SteelLtd's (TPE:2015) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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 Feng Hsin SteelLtd (TPE:2015).

It's good to see that over the last twelve months Feng Hsin SteelLtd made a profit of NT$2.39b on revenue of NT$26.8b. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its revenue has slipped in the last twelve months.

View our latest analysis for Feng Hsin SteelLtd

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. So today we'll look at what Feng Hsin SteelLtd's cashflow tells us about the quality of its earnings. 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.

Zooming In On Feng Hsin SteelLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2020, Feng Hsin SteelLtd had an accrual ratio of -0.11. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$4.2b, well over the NT$2.39b it reported in profit. Feng Hsin SteelLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Feng Hsin SteelLtd's Profit Performance

Feng Hsin SteelLtd's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Feng Hsin SteelLtd's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 11% per year over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Feng Hsin SteelLtd at this point in time. Every company has risks, and we've spotted 1 warning sign for Feng Hsin SteelLtd you should know about.

This note has only looked at a single factor that sheds light on the nature of Feng Hsin SteelLtd'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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