Ta-Yuan Cogeneration's (GTSM:8931) Earnings Are Growing But Is There More To The Story?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Ta-Yuan Cogeneration (GTSM:8931).

We like the fact that Ta-Yuan Cogeneration made a profit of NT$179.6m on its revenue of NT$1.81b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

View our latest analysis for Ta-Yuan Cogeneration

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, today we're going to take a closer look at Ta-Yuan Cogeneration's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ta-Yuan Cogeneration.

A Closer Look At Ta-Yuan Cogeneration'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, Ta-Yuan Cogeneration had an accrual ratio of 0.28. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of NT$456m, in contrast to the aforementioned profit of NT$179.6m. We also note that Ta-Yuan Cogeneration's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$456m. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

Unfortunately (in the short term) Ta-Yuan Cogeneration saw its profit reduced by unusual items worth NT$49m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Ta-Yuan Cogeneration doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Ta-Yuan Cogeneration's Profit Performance

Ta-Yuan Cogeneration saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Based on these factors, it's hard to tell if Ta-Yuan Cogeneration's profits are a reasonable reflection of its underlying profitability. If you'd like to know more about Ta-Yuan Cogeneration as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 2 warning signs (1 can't be ignored!) that you ought to be aware of before buying any shares in Ta-Yuan Cogeneration.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 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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