We Think Net Publishing's (GTSM:6542) Statutory Profit Might Understate Its Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing Net Publishing (GTSM:6542).

We like the fact that Net Publishing made a profit of NT$40.2m on its revenue of NT$884.3m, in the last year.

Check out our latest analysis for Net Publishing

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. Today, we'll discuss Net Publishing's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Net Publishing.

Examining Cashflow Against Net Publishing'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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, Net Publishing had an accrual ratio of -0.30. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of NT$115m, well over the NT$40.2m it reported in profit. Net Publishing's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On Net Publishing's Profit Performance

Happily for shareholders, Net Publishing produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Net Publishing's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And one can definitely find a positive in the fact that it made a profit this year, despite losing money 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. If you'd like to know more about Net Publishing as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Net Publishing (1 can't be ignored!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Net Publishing'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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