We Think ASIX Electronics's (GTSM:3169) Statutory Profit Might Understate Its Earnings Potential

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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 ASIX Electronics (GTSM:3169).

We like the fact that ASIX Electronics made a profit of NT$135.5m on its revenue of NT$681.4m, in the last year. As you can see in the chart below, it has grown its profits over the last three years, despite the fact its revenue has been steady.

Check out our latest analysis for ASIX Electronics

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss ASIX Electronics' 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 ASIX Electronics.

A Closer Look At ASIX Electronics' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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, ASIX Electronics recorded an accrual ratio of -0.42. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$221m during the period, dwarfing its reported profit of NT$135.5m. ASIX Electronics' free cash flow improved over the last year, which is generally good to see.

Our Take On ASIX Electronics' Profit Performance

Happily for shareholders, ASIX Electronics produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think ASIX Electronics' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 35% annually, over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing ASIX Electronics at this point in time. Every company has risks, and we've spotted 2 warning signs for ASIX Electronics you should know about.

Today we've zoomed in on a single data point to better understand the nature of ASIX Electronics' 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. 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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