Is There More To The Story Than Elite Semiconductor Microelectronics Tech's (TPE:3006) Earnings Growth?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Elite Semiconductor Microelectronics Tech (TPE:3006).

While Elite Semiconductor Microelectronics Tech was able to generate revenue of NT$14.0b in the last twelve months, we think its profit result of NT$1.04b was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Elite Semiconductor Microelectronics Tech

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 Elite Semiconductor Microelectronics Tech's 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 Elite Semiconductor Microelectronics Tech.

Zooming In On Elite Semiconductor Microelectronics Tech's 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). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to September 2020, Elite Semiconductor Microelectronics Tech had an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of NT$852m, in contrast to the aforementioned profit of NT$1.04b. It's worth noting that Elite Semiconductor Microelectronics Tech generated positive FCF of NT$826m a year ago, so at least they've done it in the past. One positive for Elite Semiconductor Microelectronics Tech shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Our Take On Elite Semiconductor Microelectronics Tech's Profit Performance

As we discussed above, we think Elite Semiconductor Microelectronics Tech's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Elite Semiconductor Microelectronics Tech's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 2 warning signs for Elite Semiconductor Microelectronics Tech (1 is potentially serious) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Elite Semiconductor Microelectronics Tech's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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