Syscom Computer Engineering (TPE:2453) Is Growing Earnings But Are They A Good Guide?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Syscom Computer Engineering's (TPE:2453) statutory profits are a good guide to its underlying earnings.

While Syscom Computer Engineering was able to generate revenue of NT$5.39b in the last twelve months, we think its profit result of NT$110.2m was more important. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Syscom Computer Engineering

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. As a result, today we're going to take a closer look at Syscom Computer Engineering's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Syscom Computer Engineering.

Examining Cashflow Against Syscom Computer Engineering's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2019, Syscom Computer Engineering had an accrual ratio of 0.41. 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. Over the last year it actually had negative free cash flow of NT$679m, in contrast to the aforementioned profit of NT$110.2m. Unfortunately, we don't have data on Syscom Computer Engineering's free cash flow for the prior year; that's not necessarily a bad thing, though we do generally prefer to be able to see a bit of a company's history.

Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for Syscom Computer Engineering 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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Syscom Computer Engineering's profit was boosted by unusual items worth NT$5.1m in the last twelve months. We can't deny that higher profits generally leave us optmistic, 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. Which is hardly suprising, given the name. 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 Syscom Computer Engineering's Profit Performance

Summing up, Syscom Computer Engineering received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Syscom Computer Engineering's statutory profits might make it look better than it really is on an underlying level. While earnings are important, another area to consider is the balance sheet. If you want to,you can see our take on Syscom Computer Engineering's balance sheet by clicking here.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.