Johnson Chemical Pharmaceutical Works (GTSM:4747) Is Growing Earnings But Are They A Good Guide?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Johnson Chemical Pharmaceutical Works' (GTSM:4747) statutory profits are a good guide to its underlying earnings.

We like the fact that Johnson Chemical Pharmaceutical Works made a profit of NT$71.8m on its revenue of NT$444.8m, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Johnson Chemical Pharmaceutical Works

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. As a result, we think it's well worth considering what Johnson Chemical Pharmaceutical Works' 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 Johnson Chemical Pharmaceutical Works.

Zooming In On Johnson Chemical Pharmaceutical Works' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Johnson Chemical Pharmaceutical Works has an accrual ratio of 0.24 for the year to September 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of NT$73m, in contrast to the aforementioned profit of NT$71.8m. It's worth noting that Johnson Chemical Pharmaceutical Works generated positive FCF of NT$30m a year ago, so at least they've done it in the past.

Our Take On Johnson Chemical Pharmaceutical Works' Profit Performance

Johnson Chemical Pharmaceutical Works 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 Johnson Chemical Pharmaceutical Works' statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 17% per annum growth in EPS for the last three. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Johnson Chemical Pharmaceutical Works, you'd also look into what risks it is currently facing. For instance, we've identified 2 warning signs for Johnson Chemical Pharmaceutical Works (1 is potentially serious) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Johnson Chemical Pharmaceutical Works' 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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