Should You Rely On United Microelectronics's (TPE:2303) Earnings Growth?

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. This article will consider whether United Microelectronics' (TPE:2303) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months United Microelectronics made a profit of NT$21.8b on revenue of NT$173.4b. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for United Microelectronics

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. Therefore, today we'll take a look at United Microelectronics' 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.

Zooming In On United Microelectronics' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Over the twelve months to September 2020, United Microelectronics recorded an accrual ratio of -0.23. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$66b, well over the NT$21.8b it reported in profit. United Microelectronics shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, United Microelectronics increased the number of shares on issue by 5.1% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of United Microelectronics' EPS by clicking here.

A Look At The Impact Of United Microelectronics' Dilution on Its Earnings Per Share (EPS).

As you can see above, United Microelectronics has been growing its net income over the last few years, with an annualized gain of 104% over three years. And the 417% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 414% 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.

In the long term, earnings per share growth should beget share price growth. So United Microelectronics 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 that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that United Microelectronics' profit was boosted by unusual items worth NT$1.2b in the last twelve months. 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, after all, that's exactly what the accounting terminology implies. If United Microelectronics 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 United Microelectronics' Profit Performance

Summing up, United Microelectronics' accrual ratio suggests that its statutory earnings are well matched by cash flow while its unusual items boosted the profit in a way that might not be repeated. Meanwhile, the dilution was a negative for shareholders. Based on these factors, it's hard to tell if United Microelectronics' profits are a reasonable reflection of its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing United Microelectronics at this point in time. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of United Microelectronics.

Our examination of United Microelectronics 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. 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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