Chief Telecom's (GTSM:6561) Earnings Are Growing But Is There More To The Story?

Statistically speaking, it is less risky to invest in profitable companies than in 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Chief Telecom (GTSM:6561).

While Chief Telecom was able to generate revenue of NT$2.51b in the last twelve months, we think its profit result of NT$587.7m was more important. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for Chief Telecom

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what Chief Telecom's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chief Telecom.

Zooming In On Chief Telecom's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

Chief Telecom has an accrual ratio of -0.32 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of NT$651m, well over the NT$587.7m it reported in profit. Chief Telecom's year-on-year free cash flow was as flat as two-day-old fizzy drink.

Our Take On Chief Telecom's Profit Performance

Happily for shareholders, Chief Telecom produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Chief Telecom's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 40% per year over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Chief Telecom at this point in time. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Chief Telecom.

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