Here's Why Compal Electronics's (TPE:2324) Statutory Earnings Are Arguably Too Conservative

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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Compal Electronics (TPE:2324).

It's good to see that over the last twelve months Compal Electronics made a profit of NT$6.79b on revenue of NT$982.5b. 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 Compal Electronics

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. So today we'll look at what Compal Electronics' cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Examining Cashflow Against Compal 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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Compal Electronics has an accrual ratio of -0.23 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of NT$38b in the last year, which was a lot more than its statutory profit of NT$6.79b. Compal Electronics' free cash flow improved over the last year, which is generally good to see.

Our Take On Compal Electronics' Profit Performance

Happily for shareholders, Compal Electronics produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Compal Electronics' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 8.1% annually, 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. If you want to do dive deeper into Compal Electronics, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Compal Electronics has 2 warning signs and it would be unwise to ignore them.

Today we've zoomed in on a single data point to better understand the nature of Compal Electronics' 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. 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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