We Think Taiwan Alpha Electronic's (GTSM:6204) Statutory Profit Might Understate Its Earnings Potential

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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Taiwan Alpha Electronic (GTSM:6204).

While Taiwan Alpha Electronic was able to generate revenue of NT$455.5m in the last twelve months, we think its profit result of NT$34.8m was more important. Below, you can see that both its revenue and its profit have fallen over the last three years.

View our latest analysis for Taiwan Alpha Electronic

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. Today, we'll discuss Taiwan Alpha Electronic's 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 Taiwan Alpha Electronic.

A Closer Look At Taiwan Alpha Electronic'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. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 2020, Taiwan Alpha Electronic had an accrual ratio of -0.36. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$86m in the last year, which was a lot more than its statutory profit of NT$34.8m. Taiwan Alpha Electronic shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Taiwan Alpha Electronic's Profit Performance

Happily for shareholders, Taiwan Alpha Electronic produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Taiwan Alpha Electronic'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 increased by 43% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To help with this, we've discovered 3 warning signs (1 can't be ignored!) that you ought to be aware of before buying any shares in Taiwan Alpha Electronic.

This note has only looked at a single factor that sheds light on the nature of Taiwan Alpha Electronic's profit. 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. 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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