Taiwan Surface Mounting Technology's (TPE:6278) Solid Earnings May Rest On Weak Foundations

Taiwan Surface Mounting Technology Corp.'s (TPE:6278) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

See our latest analysis for Taiwan Surface Mounting Technology

Zooming In On Taiwan Surface Mounting 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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Taiwan Surface Mounting Technology has an accrual ratio of 0.35 for the year to December 2020. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In the last twelve months it actually had negative free cash flow, with an outflow of NT$1.1b despite its profit of NT$2.19b, mentioned above. We saw that FCF was NT$3.7b a year ago though, so Taiwan Surface Mounting Technology has at least been able to generate positive FCF in the past. One positive for Taiwan Surface Mounting Technology 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

Our Take On Taiwan Surface Mounting Technology's Profit Performance

As we discussed above, we think Taiwan Surface Mounting Technology's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Taiwan Surface Mounting Technology's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. If you'd like to know more about Taiwan Surface Mounting Technology as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Taiwan Surface Mounting Technology (1 doesn't sit too well with us!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Taiwan Surface Mounting 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. 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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