We Think Advancetek EnterpriseLtd's (TWSE:1442) Solid Earnings Are Understated

Advancetek Enterprise Co.,Ltd. (TWSE:1442) announced a healthy earnings result recently, and the market rewarded it with a strong uplift in the stock price. This reaction by the market reaction is understandable when looking at headline profits and we have found some further encouraging factors.

View our latest analysis for Advancetek EnterpriseLtd

Examining Cashflow Against Advancetek EnterpriseLtd'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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Advancetek EnterpriseLtd has an accrual ratio of -0.18 for the year to June 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of NT$5.3b during the period, dwarfing its reported profit of NT$2.90b. Given that Advancetek EnterpriseLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of NT$5.3b would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Advancetek EnterpriseLtd.

Our Take On Advancetek EnterpriseLtd's Profit Performance

As we discussed above, Advancetek EnterpriseLtd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Advancetek EnterpriseLtd's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate 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. 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. While conducting our analysis, we found that Advancetek EnterpriseLtd has 2 warning signs and it would be unwise to ignore them.

This note has only looked at a single factor that sheds light on the nature of Advancetek EnterpriseLtd'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 with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.