Should You Rely On Champion Microelectronic's (TPE:3257) 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 Champion Microelectronic's (TPE:3257) statutory profits are a good guide to its underlying earnings.

While Champion Microelectronic was able to generate revenue of NT$934.8m in the last twelve months, we think its profit result of NT$191.5m was more important. We know some investors love those high revenue growth stocks, but we do like to look at profit, even if it is, perhaps, a bit old fashioned. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for Champion Microelectronic

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. So today we'll look at what Champion Microelectronic'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 Champion Microelectronic.

Zooming In On Champion Microelectronic'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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2020, Champion Microelectronic recorded an accrual ratio of -0.15. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of NT$289m, well over the NT$191.5m it reported in profit. Champion Microelectronic's free cash flow improved over the last year, which is generally good to see.

Our Take On Champion Microelectronic's Profit Performance

Champion Microelectronic's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Champion Microelectronic's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at an extremely impressive rate 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. If you want to do dive deeper into Champion Microelectronic, you'd also look into what risks it is currently facing. For example, Champion Microelectronic has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Champion Microelectronic's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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