Does Powertip Image's (GTSM:6498) Statutory Profit Adequately Reflect Its Underlying Profit?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Powertip Image (GTSM:6498).

It's good to see that over the last twelve months Powertip Image made a profit of NT$58.6m on revenue of NT$527.5m. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

See our latest analysis for Powertip Image

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 Powertip Image's cashflow tells 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 Powertip Image.

Examining Cashflow Against Powertip Image'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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.

Over the twelve months to June 2020, Powertip Image recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of NT$58.6m, a look at free cash flow indicates it actually burnt through NT$1.3m in the last year. We saw that FCF was NT$28m a year ago though, so Powertip Image has at least been able to generate positive FCF in the past. One positive for Powertip Image shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Our Take On Powertip Image's Profit Performance

Powertip Image's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Powertip Image's true underlying earnings power is actually less than its statutory profit. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 2 warning signs for Powertip Image (1 is concerning) you should be familiar with.

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