Why GEM Services' (TWSE:6525) Earnings Are Better Than They Seem

The market seemed underwhelmed by last week's earnings announcement from GEM Services, Inc. (TWSE:6525) despite the healthy numbers. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

View our latest analysis for GEM Services

Examining Cashflow Against GEM Services' 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 2024, GEM Services had an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$1.1b, well over the NT$580.3m it reported in profit. GEM Services shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of GEM Services.

Our Take On GEM Services' Profit Performance

As we discussed above, GEM Services' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think GEM Services' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about GEM Services as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for GEM Services you should be mindful of and 1 of them can't be ignored.

Today we've zoomed in on a single data point to better understand the nature of GEM Services' 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.