Despite posting some strong earnings, the market for M3 Technology Inc.'s (GTSM:6799) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.
Examining Cashflow Against M3 Technology's Earnings
Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.
For the year to December 2020, M3 Technology had an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Indeed, in the last twelve months it reported free cash flow of NT$105m, which is significantly less than its profit of NT$137.0m. At this point we should mention that M3 Technology did manage to increase its free cash flow in the last twelve months
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of M3 Technology.
Our Take On M3 Technology's Profit Performance
M3 Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that M3 Technology's statutory profits are better than its underlying earnings power. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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 while earnings quality is important, it's equally important to consider the risks facing M3 Technology at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of M3 Technology.
This note has only looked at a single factor that sheds light on the nature of M3 Technology'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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