Should You Rely On Thermaltake Technology's (GTSM:3540) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Thermaltake Technology's (GTSM:3540) statutory profits are a good guide to its underlying earnings.

While Thermaltake Technology was able to generate revenue of NT$4.96b in the last twelve months, we think its profit result of NT$373.2m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Thermaltake Technology

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. So today we'll look at what Thermaltake Technology's cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Examining Cashflow Against Thermaltake Technology's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2020, Thermaltake Technology had an accrual ratio of -0.18. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of NT$642m during the period, dwarfing its reported profit of NT$373.2m. Given that Thermaltake Technology had negative free cash flow in the prior corresponding period, the trailing twelve month resul of NT$642m would seem to be a step in the right direction.

Our Take On Thermaltake Technology's Profit Performance

As we discussed above, Thermaltake Technology's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Thermaltake Technology's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, 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. So while earnings quality is important, it's equally important to consider the risks facing Thermaltake Technology at this point in time. In terms of investment risks, we've identified 1 warning sign with Thermaltake Technology, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Thermaltake Technology's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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