We Think Sincere Navigation's (TPE:2605) Healthy Earnings Might Be Conservative

The market seemed underwhelmed by last week's earnings announcement from Sincere Navigation Corporation (TPE:2605) despite the healthy numbers. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

See our latest analysis for Sincere Navigation

Zooming In On Sincere Navigation's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2020, Sincere Navigation recorded an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of NT$2.1b in the last year, which was a lot more than its statutory profit of NT$193.2m. Sincere Navigation shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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.

How Do Unusual Items Influence Profit?

Sincere Navigation's profit was reduced by unusual items worth NT$303m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Sincere Navigation took a rather significant hit from unusual items in the year to December 2020. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On Sincere Navigation's Profit Performance

Considering both Sincere Navigation's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Sincere Navigation's earnings potential is at least as good as it seems, and maybe even better! 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. For instance, we've identified 3 warning signs for Sincere Navigation (1 doesn't sit too well with us) you should be familiar with.

After our examination into the nature of Sincere Navigation's profit, we've come away optimistic for the company. 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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