We Think Compal Broadband Networks' (TPE:6674) Healthy Earnings Might Be Conservative

Compal Broadband Networks, Inc.'s (TPE:6674) solid earnings announcement recently didn't do much to the stock price. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

View our latest analysis for Compal Broadband Networks

Zooming In On Compal Broadband Networks' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Compal Broadband Networks has an accrual ratio of -1.39 for the year to December 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of NT$620m during the period, dwarfing its reported profit of NT$46.7m. Compal Broadband Networks' free cash flow improved over the last year, which is generally good to see. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Compal Broadband Networks.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Compal Broadband Networks received a tax benefit of NT$1.7m. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! The receipt of a tax benefit is obviously a good thing, on its own. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.

Our Take On Compal Broadband Networks' Profit Performance

While Compal Broadband Networks' accrual ratio stands testament to its strong cashflow, and indicates good quality earnings, the fact that it received a tax benefit suggests that this year's profit may not be a great guide to its sustainable profit run-rate. Based on these factors, we think that Compal Broadband Networks' profits are a reasonably conservative guide to its underlying profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 3 warning signs (1 shouldn't be ignored!) that you ought to be aware of before buying any shares in Compal Broadband Networks.

Our examination of Compal Broadband Networks has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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