Fuzetec Technology's (GTSM:6642) Earnings Are Growing But Is There More To The Story?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Fuzetec Technology's (GTSM:6642) statutory profits are a good guide to its underlying earnings.

We like the fact that Fuzetec Technology made a profit of NT$69.4m on its revenue of NT$413.6m, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for Fuzetec Technology

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 Fuzetec Technology'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 Fuzetec Technology.

Zooming In On Fuzetec Technology's 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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Fuzetec Technology recorded an accrual ratio of -0.13. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of NT$87m, well over the NT$69.4m it reported in profit. Fuzetec Technology did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

Our Take On Fuzetec Technology's Profit Performance

As we discussed above, Fuzetec Technology has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Fuzetec Technology's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 25% per year over the last three years. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. You'd be interested to know, that we found 2 warning signs for Fuzetec Technology and you'll want to know about these.

This note has only looked at a single factor that sheds light on the nature of Fuzetec Technology's 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.

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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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