Sea Sonic Electronics (GTSM:6203) Is Growing Earnings But Are They A Good Guide?

As a general rule, we think profitable companies are less risky than companies that lose money. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing Sea Sonic Electronics (GTSM:6203).

While Sea Sonic Electronics was able to generate revenue of NT$3.17b in the last twelve months, we think its profit result of NT$484.4m was more important. One positive is that it has grown both its profit and its revenue, over the last few years.

See our latest analysis for Sea Sonic Electronics

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. Today, we'll discuss Sea Sonic Electronics' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sea Sonic Electronics.

Examining Cashflow Against Sea Sonic Electronics' 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2020, Sea Sonic Electronics recorded an accrual ratio of -0.62. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of NT$842m during the period, dwarfing its reported profit of NT$484.4m. Sea Sonic Electronics' free cash flow improved over the last year, which is generally good to see.

Our Take On Sea Sonic Electronics' Profit Performance

Happily for shareholders, Sea Sonic Electronics produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Sea Sonic Electronics' 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 Sea Sonic Electronics at this point in time. At Simply Wall St, we found 1 warning sign for Sea Sonic Electronics and we think they deserve your attention.

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

When trading Sea Sonic Electronics or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.