Weak Statutory Earnings May Not Tell The Whole Story For Formosa Sumco Technology (TWSE:3532)

The market wasn't impressed with the soft earnings from Formosa Sumco Technology Corporation (TWSE:3532) recently. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

See our latest analysis for Formosa Sumco Technology

A Closer Look At Formosa Sumco 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Formosa Sumco Technology recorded an accrual ratio of 0.36. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of NT$1.54b, a look at free cash flow indicates it actually burnt through NT$11b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of NT$11b, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Formosa Sumco Technology.

Our Take On Formosa Sumco Technology's Profit Performance

As we have made quite clear, we're a bit worried that Formosa Sumco Technology didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Formosa Sumco Technology's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 16% per annum growth in EPS for the last three. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 4 warning signs for Formosa Sumco Technology you should be mindful of and 3 of them don't sit too well with us.

Today we've zoomed in on a single data point to better understand the nature of Formosa Sumco Technology's profit. 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 with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.