Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. In this article, we’ll look at how useful this year’s statutory profit is, when analysing EPS Bio Technology (GTSM:4183).
While EPS Bio Technology was able to generate revenue of NT$496.6m in the last twelve months, we think its profit result of NT$33.5m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we’ll discuss EPS Bio Technology’s free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of EPS Bio Technology.
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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. The ratio shows us how much a company’s profit exceeds its FCF.
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.
EPS Bio Technology has an accrual ratio of -0.59 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of NT$114m in the last year, which was a lot more than its statutory profit of NT$33.5m. EPS Bio Technology’s free cash flow improved over the last year, which is generally good to see.
Happily for shareholders, EPS Bio Technology produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think EPS Bio Technology’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 an extremely impressive rate over the last three years. At the end of the day, it’s essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it’s worth noting the risks involved. For example – EPS Bio Technology has 2 warning signs we think you should be aware of.
Today we’ve zoomed in on a single data point to better understand the nature of EPS Bio Technology’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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