We Think That There Are More Issues For DFI (TWSE:2397) Than Just Sluggish Earnings

DFI Inc.'s (TWSE:2397) earnings announcement last week contained some soft numbers, disappointing investors. Our analysis suggests that while the headline numbers were soft, there are some positive factors which shareholders may have missed.

See our latest analysis for DFI

A Closer Look At DFI'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'.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, DFI recorded an accrual ratio of -0.10. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of NT$960m in the last year, which was a lot more than its statutory profit of NT$305.8m. DFI's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

Surprisingly, given DFI's accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$59m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If DFI 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 DFI's Profit Performance

DFI's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if DFI's profits are a reasonable reflection of its underlying profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 4 warning signs for DFI you should be mindful of and 1 of these shouldn't be ignored.

Our examination of DFI 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. 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 with significant insider holdings to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.