Is There More To The Story Than PCL Technologies' (TPE:4977) Earnings Growth?

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 PCL Technologies (TPE:4977).

It's good to see that over the last twelve months PCL Technologies made a profit of NT$461.7m on revenue of NT$3.16b. One positive is that it has grown both its profit and its revenue, over the last few years.

See our latest analysis for PCL Technologies

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. As a result, today we're going to take a closer look at PCL Technologies' cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. 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 PCL Technologies' 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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

PCL Technologies has an accrual ratio of 0.22 for the year to September 2020. 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$92m, which is significantly less than its profit of NT$461.7m. PCL Technologies' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for PCL Technologies shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by NT$46m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If PCL Technologies doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On PCL Technologies' Profit Performance

Summing up, PCL Technologies received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue PCL Technologies' profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 3 warning signs for PCL Technologies (of which 1 can't be ignored!) you should know about.

Our examination of PCL 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 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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