Why Formosa Sumco Technology's (TWSE:3532) Shaky Earnings Are Just The Beginning Of Its Problems

Formosa Sumco Technology Corporation's (TWSE:3532) recent weak earnings report didn't cause a big stock movement. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

View our latest analysis for Formosa Sumco Technology

Zooming In On 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. 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. 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 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. 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 December 2023, Formosa Sumco Technology recorded an accrual ratio of 0.78. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of NT$15b, in contrast to the aforementioned profit of NT$3.46b. It's worth noting that Formosa Sumco Technology generated positive FCF of NT$2.3b a year ago, so at least they've done it in the past.

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 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. When we did our research, we found 2 warning signs for Formosa Sumco Technology (1 is potentially serious!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on 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. 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. 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.