We're Not So Sure You Should Rely on Hitron Technologies's (TPE:2419) Statutory Earnings

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Hitron Technologies (TPE:2419).

We like the fact that Hitron Technologies made a profit of NT$245.9m on its revenue of NT$9.48b, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

View our latest analysis for Hitron Technologies

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. So today we'll look at what Hitron Technologies' cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hitron Technologies.

Zooming In On Hitron Technologies' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 September 2020, Hitron Technologies recorded an accrual ratio of 0.26. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of NT$729m, in contrast to the aforementioned profit of NT$245.9m. We saw that FCF was NT$875m a year ago though, so Hitron Technologies has at least been able to generate positive FCF in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. The good news for shareholders is that Hitron Technologies' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Hitron Technologies expanded the number of shares on issue by 40% over the last year. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Hitron Technologies' EPS by clicking here.

How Is Dilution Impacting Hitron Technologies' Earnings Per Share? (EPS)

Hitron Technologies' net profit dropped by 43% per year over the last three years. However, profit was steady in the last year. But EPS was considerably worse, since it declined 19% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, if Hitron Technologies' earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Hitron Technologies' Profit Performance

In conclusion, Hitron Technologies has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Hitron Technologies' statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Hitron Technologies, you'd also look into what risks it is currently facing. When we did our research, we found 4 warning signs for Hitron Technologies (3 are significant!) that we believe deserve your full attention.

Our examination of Hitron Technologies has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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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