Good Will Instrument's (TPE:2423) Soft Earnings Are Actually Better Than They Appear

Shareholders appeared unconcerned with Good Will Instrument Co., Ltd.'s (TPE:2423) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for Good Will Instrument

A Closer Look At Good Will Instrument'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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Good Will Instrument has an accrual ratio of -0.13 for the year to December 2020. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of NT$451m during the period, dwarfing its reported profit of NT$199.1m. Good Will Instrument's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Good Will Instrument.

Our Take On Good Will Instrument's Profit Performance

As we discussed above, Good Will Instrument has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Good Will Instrument's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 1 warning sign for Good Will Instrument you should know about.

Today we've zoomed in on a single data point to better understand the nature of Good Will Instrument's profit. But there are plenty of other ways to inform your opinion of a company. 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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