Should You Rely On Century Iron and Steel IndustrialLtd's (TPE:9958) Earnings Growth?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Century Iron and Steel IndustrialLtd (TPE:9958).

It's good to see that over the last twelve months Century Iron and Steel IndustrialLtd made a profit of NT$748.7m on revenue of NT$5.50b. We know some investors love those high revenue growth stocks, but we do like to look at profit, even if it is, perhaps, a bit old fashioned. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for Century Iron and Steel IndustrialLtd

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Century Iron and Steel IndustrialLtd'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.

A Closer Look At Century Iron and Steel IndustrialLtd'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. 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 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. 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, Century Iron and Steel IndustrialLtd had an accrual ratio of 0.20. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of NT$656m despite its profit of NT$748.7m, mentioned above. We also note that Century Iron and Steel IndustrialLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$656m.

Our Take On Century Iron and Steel IndustrialLtd's Profit Performance

Century Iron and Steel IndustrialLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Century Iron and Steel IndustrialLtd's statutory profits are better than its underlying earnings power. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. If you want to do dive deeper into Century Iron and Steel IndustrialLtd, you'd also look into what risks it is currently facing. For instance, we've identified 4 warning signs for Century Iron and Steel IndustrialLtd (1 is concerning) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Century Iron and Steel IndustrialLtd'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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