Here's Why Lifestyle Global Enterprise's (GTSM:8066) Statutory Earnings Are Arguably Too Conservative

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. This article will consider whether Lifestyle Global Enterprise's (GTSM:8066) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Lifestyle Global Enterprise made a profit of NT$77.4m on revenue of NT$6.19b. The chart below shows that both revenue and profit have declined over the last three years.

Check out our latest analysis for Lifestyle Global Enterprise

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. Today, we'll discuss Lifestyle Global Enterprise'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 Lifestyle Global Enterprise.

Zooming In On Lifestyle Global Enterprise's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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'.

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.

Lifestyle Global Enterprise has an accrual ratio of -0.25 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$272m during the period, dwarfing its reported profit of NT$77.4m. Lifestyle Global Enterprise's free cash flow improved over the last year, which is generally good to see.

Our Take On Lifestyle Global Enterprise's Profit Performance

Happily for shareholders, Lifestyle Global Enterprise produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Lifestyle Global Enterprise's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the 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. 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. Be aware that Lifestyle Global Enterprise is showing 5 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

This note has only looked at a single factor that sheds light on the nature of Lifestyle Global Enterprise's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.

If you’re looking to trade Lifestyle Global Enterprise, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.