Taiwan Kong KingLtd (GTSM:3093) 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Taiwan Kong KingLtd (GTSM:3093).

We like the fact that Taiwan Kong KingLtd made a profit of NT$126.2m on its revenue of NT$1.33b, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

See our latest analysis for Taiwan Kong KingLtd

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Taiwan Kong KingLtd's cashflow and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Taiwan Kong KingLtd.

A Closer Look At Taiwan Kong KingLtd'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). 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2020, Taiwan Kong KingLtd recorded an accrual ratio of -0.16. 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$201m, well over the NT$126.2m it reported in profit. Given that Taiwan Kong KingLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of NT$201m would seem to be a step in the right direction. 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.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Taiwan Kong KingLtd's profit was boosted by unusual items worth NT$10m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, 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 Taiwan Kong KingLtd's Profit Performance

In conclusion, Taiwan Kong KingLtd's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that Taiwan Kong KingLtd's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into Taiwan Kong KingLtd, you'd also look into what risks it is currently facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Taiwan Kong KingLtd.

Our examination of Taiwan Kong KingLtd has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.

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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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