Should You Use Pan German Universal Motors's (TPE:2247) Statutory Earnings To Analyse It?

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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Pan German Universal Motors (TPE:2247).

We like the fact that Pan German Universal Motors made a profit of NT$1.02b on its revenue of NT$38.6b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Pan German Universal Motors

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. 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.

A Closer Look At Pan German Universal Motors' 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). 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. The ratio shows us how much a company's profit exceeds its FCF.

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

Over the twelve months to September 2020, Pan German Universal Motors recorded an accrual ratio of -0.14. That indicates that its free cash flow was a fair bit more than its statutory profit. 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. Given that Pan German Universal Motors had negative free cash flow in the prior corresponding period, the trailing twelve month resul of NT$2.1b would seem to be a step in the right direction. However, that's not the end of the story. 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Pan German Universal Motors issued 13% more new shares 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.

How Is Dilution Impacting Pan German Universal Motors' 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. In contrast, earnings per share were actually down by 0.9% per year, in the exact same period. And at a glance the 53% gain in profit over the last year impresses. But in comparison, EPS only increased by 53% over the same period. 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.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. 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$101m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. 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. Meanwhile, the dilution was a negative for shareholders. 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. If you'd like to know more about Pan German Universal Motors as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 4 warning signs for Pan German Universal Motors you should be mindful of and 1 of them is a bit unpleasant.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.

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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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