Here's Why Wholetech System Hitech's (GTSM:3402) Statutory Earnings Are Arguably Too Conservative

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Wholetech System Hitech's (GTSM:3402) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Wholetech System Hitech made a profit of NT$200.7m on revenue of NT$2.75b. The chart below shows how profit has actually increased over the last three years, even while revenue has declined.

View our latest analysis for Wholetech System Hitech

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. So today we'll look at what Wholetech System Hitech's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wholetech System Hitech.

Zooming In On Wholetech System Hitech's 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Wholetech System Hitech has an accrual ratio of -0.49 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of NT$664m during the period, dwarfing its reported profit of NT$200.7m. Given that Wholetech System Hitech had negative free cash flow in the prior corresponding period, the trailing twelve month resul of NT$664m would seem to be a step in the right direction.

Our Take On Wholetech System Hitech's Profit Performance

Happily for shareholders, Wholetech System Hitech produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Wholetech System Hitech's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 6.9% per year over the last three years. 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. Case in point: We've spotted 2 warning signs for Wholetech System Hitech you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Wholetech System Hitech'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.

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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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