As a general rule, we think profitable companies are less risky than companies that lose money. 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 Dacome International (GTSM:9960).
We like the fact that Dacome International made a profit of NT$39.6m on its revenue of NT$464.2m, in the last year. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.
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. As a result, we think it's well worth considering what Dacome International's 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 Dacome International.
A Closer Look At Dacome International'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). 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. 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. 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. 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, Dacome International had an accrual ratio of -0.42. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of NT$77m in the last year, which was a lot more than its statutory profit of NT$39.6m. Dacome International shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On Dacome International's Profit Performance
Happily for shareholders, Dacome International produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Dacome International's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 22% over the last twelve months. 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. 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. For example - Dacome International has 2 warning signs we think you should be aware of.
This note has only looked at a single factor that sheds light on the nature of Dacome International'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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