Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Cypress TechnologyLtd (GTSM:3541).
It’s good to see that over the last twelve months Cypress TechnologyLtd made a profit of NT$304.8m on revenue of NT$2.21b. One positive is that it has grown both its profit and its revenue, over the last few years.
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. So today we’ll look at what Cypress TechnologyLtd’s cashflow tells us about the quality of its earnings. 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.
A Closer Look At Cypress TechnologyLtd’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’.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Cypress TechnologyLtd has an accrual ratio of -0.36 for the year to September 2019. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$544m in the last year, which was a lot more than its statutory profit of NT$304.8m. Cypress TechnologyLtd’s free cash flow improved over the last year, which is generally good to see.
Our Take On Cypress TechnologyLtd’s Profit Performance
As we discussed above, Cypress TechnologyLtd’s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Cypress TechnologyLtd’s statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 32% 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 Cypress TechnologyLtd at this point in time. Every company has risks, and we’ve spotted 2 warning signs for Cypress TechnologyLtd you should know about.
Today we’ve zoomed in on a single data point to better understand the nature of Cypress TechnologyLtd’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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
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