We Think Fitipower Integrated Technology's (TPE:4961) Statutory Profit Might Understate Its Earnings Potential

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Fitipower Integrated Technology (TPE:4961).

While Fitipower Integrated Technology was able to generate revenue of NT$9.61b in the last twelve months, we think its profit result of NT$272.8m was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).

See our latest analysis for Fitipower Integrated Technology

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 Fitipower Integrated Technology'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 Fitipower Integrated Technology.

Zooming In On Fitipower Integrated Technology'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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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

For the year to September 2020, Fitipower Integrated Technology had an accrual ratio of -0.34. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of NT$1.2b, well over the NT$272.8m it reported in profit. Fitipower Integrated Technology's free cash flow improved over the last year, which is generally good to see.

Our Take On Fitipower Integrated Technology's Profit Performance

Happily for shareholders, Fitipower Integrated Technology produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Fitipower Integrated Technology's statutory profit actually understates its earnings potential! And it's also good to see that its earnings per share have improved a bit over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Fitipower Integrated Technology as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Fitipower Integrated Technology, and understanding it should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Fitipower Integrated Technology'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. 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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