Should You Use Chialin Precision Industrial's (GTSM:3310) Statutory Earnings To Analyse It?

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. In this article, we'll look at how useful this year's statutory profit is, when analysing Chialin Precision Industrial (GTSM:3310).

It's good to see that over the last twelve months Chialin Precision Industrial made a profit of NT$243.0m on revenue of NT$1.86b.

View our latest analysis for Chialin Precision Industrial

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, we'll today take a look at how dilution and cashflow shape our understanding of Chialin Precision Industrial's earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chialin Precision Industrial.

Zooming In On Chialin Precision Industrial's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Chialin Precision Industrial has an accrual ratio of -0.11 for the year to September 2020. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of NT$511m during the period, dwarfing its reported profit of NT$243.0m. Given that Chialin Precision Industrial had negative free cash flow in the prior corresponding period, the trailing twelve month resul of NT$511m would seem to be a step in the right direction. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Chialin Precision Industrial increased the number of shares on issue by 25% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Chialin Precision Industrial's historical EPS growth by clicking on this link.

A Look At The Impact Of Chialin Precision Industrial's Dilution on Its Earnings Per Share (EPS).

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, if Chialin Precision Industrial's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Chialin Precision Industrial's Profit Performance

In conclusion, Chialin Precision Industrial has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Having considered these factors, we don't think Chialin Precision Industrial's statutory profits give an overly harsh view of the business. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Chialin Precision Industrial has 4 warning signs we think you should be aware of.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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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