Alltek Technology's (TPE:3209) Earnings Are Growing But Is There More To The Story?

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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. This article will consider whether Alltek Technology's (TPE:3209) statutory profits are a good guide to its underlying earnings.

We like the fact that Alltek Technology made a profit of NT$431.4m on its revenue of NT$42.1b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Alltek Technology

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll examine what Alltek Technology's cashflow and its expanding share count tell us about the nature of its profits. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Alltek Technology.

A Closer Look At Alltek 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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

For the year to September 2020, Alltek Technology had an accrual ratio of -0.13. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of NT$1.4b, well over the NT$431.4m it reported in profit. Alltek Technology shareholders are no doubt pleased that free cash flow improved over the last twelve months. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Alltek Technology issued 7.4% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Alltek Technology's historical EPS growth by clicking on this link.

How Is Dilution Impacting Alltek Technology's Earnings Per Share? (EPS)

Alltek Technology has improved its profit over the last three years, with an annualized gain of 105% in that time. In comparison, earnings per share only gained 77% over the same period. And at a glance the 70% gain in profit over the last year impresses. On the other hand, earnings per share are only up 63% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So Alltek Technology shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Alltek Technology's Profit Performance

In conclusion, Alltek Technology has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. After taking into account all these factors, we think that Alltek Technology's statutory results are a decent reflection of its underlying earnings power. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 4 warning signs for Alltek Technology (1 is a bit concerning) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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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