Heran (TPE:5283) Is Growing Earnings But Are They A Good Guide?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Heran's (TPE:5283) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Heran made a profit of NT$912.6m on revenue of NT$6.05b. One positive is that it has grown both its profit and its revenue, over the last few years.

See our latest analysis for Heran

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. Today, we'll discuss Heran's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Heran.

Zooming In On Heran'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Heran has an accrual ratio of -0.17 for the year to September 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$1.4b in the last year, which was a lot more than its statutory profit of NT$912.6m. Heran's free cash flow improved over the last year, which is generally good to see.

Our Take On Heran's Profit Performance

As we discussed above, Heran's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Heran's statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 9.7% in the last year. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Every company has risks, and we've spotted 1 warning sign for Heran you should know about.

Today we've zoomed in on a single data point to better understand the nature of Heran's profit. 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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