ASMedia Technology (TPE:5269) Is Growing Earnings But Are They A Good Guide?

By
Simply Wall St
Published
December 31, 2020

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing ASMedia Technology (TPE:5269).

It's good to see that over the last twelve months ASMedia Technology made a profit of NT$2.44b on revenue of NT$5.99b. 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. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for ASMedia Technology

TSEC:5269 Earnings and Revenue History January 1st 2021

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 ASMedia Technology's cashflow and unusual items tell us about the quality of its earnings, as well as touching on how its recent share issues are impacting shareholders. 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 ASMedia Technology's 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. 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. 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.

For the year to September 2020, ASMedia Technology had an accrual ratio of 0.21. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. To wit, it produced free cash flow of NT$1.3b during the period, falling well short of its reported profit of NT$2.44b. We should mention, here, that ASMedia Technology free cashflow was as flat as a pancake over the last twelve months. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively. The good news for shareholders is that ASMedia Technology's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, ASMedia Technology increased the number of shares on issue by 15% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out ASMedia Technology's historical EPS growth by clicking on this link.

How Is Dilution Impacting ASMedia Technology's Earnings Per Share? (EPS)

As you can see above, ASMedia Technology has been growing its net income over the last few years, with an annualized gain of 465% over three years. In comparison, earnings per share only gained 427% over the same period. And the 134% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 119% 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.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if ASMedia Technology can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by NT$372m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On ASMedia Technology's Profit Performance

In conclusion, ASMedia Technology's weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For the reasons mentioned above, we think that a perfunctory glance at ASMedia Technology's statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, ASMedia Technology has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

Our examination of ASMedia Technology has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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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