Are Pan German Universal Motors' (TPE:2247) Statutory Earnings A Good Guide To Its Underlying Profitability?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Pan German Universal Motors (TPE:2247).

While Pan German Universal Motors was able to generate revenue of NT$38.6b in the last twelve months, we think its profit result of NT$1.02b was more important. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

Check out our latest analysis for Pan German Universal Motors

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. Therefore, today we'll take a look at Pan German Universal Motors' cashflow, share issues and unusual items with a view to better understanding the nature of its statutory earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Examining Cashflow Against Pan German Universal Motors' 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. 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.

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".

Pan German Universal Motors has an accrual ratio of -0.14 for the year to September 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of NT$2.1b in the last year, which was a lot more than its statutory profit of NT$1.02b. Notably, Pan German Universal Motors had negative free cash flow last year, so the NT$2.1b it produced this year was a welcome improvement. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Pan German Universal Motors expanded the number of shares on issue by 13% over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Pan German Universal Motors' historical EPS growth by clicking on this link.

A Look At The Impact Of Pan German Universal Motors' Dilution on Its Earnings Per Share (EPS).

Pan German Universal Motors has improved its profit over the last three years, with an annualized gain of 2.3% in that time. But on the other hand, earnings per share actually fell by 1.0% per year. And at a glance the 53% gain in profit over the last year impresses. On the other hand, earnings per share are only up 53% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So Pan German Universal Motors shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Surprisingly, given Pan German Universal Motors' accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$103m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Pan German Universal Motors doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Pan German Universal Motors' Profit Performance

In conclusion, Pan German Universal Motors' accrual ratio suggests its earnings are well backed by cash but its boost from unusual items is probably not going to be repeated consistently. Further, the dilution means profits are now split more ways. Based on these factors, we think it's very unlikely that Pan German Universal Motors' statutory profits make it seem much weaker than it is. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Pan German Universal Motors has 3 warning signs (and 1 which can't be ignored) we think you should know about.

Our examination of Pan German Universal Motors has focussed on certain factors that can make its earnings look better than they are. 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. 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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