Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Alpha Networks (TPE:3380).
It’s good to see that over the last twelve months Alpha Networks made a profit of NT$388.2m on revenue of NT$27.1b. We know some investors love those high revenue growth stocks, but we do like to look at profit, even if it is, perhaps, a bit old fashioned.
Check out our latest analysis for Alpha Networks
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 Alpha Networks’ cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Alpha Networks.
A Closer Look At Alpha Networks’ Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company’s free cash flow (FCF) matches its profit. 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’.
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. 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. 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 September 2020, Alpha Networks recorded an accrual ratio of 0.26. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of NT$388.2m, a look at free cash flow indicates it actually burnt through NT$1.5b in the last year. We also note that Alpha Networks’ free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$1.5b.
Our Take On Alpha Networks’ Profit Performance
Alpha Networks didn’t convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Alpha Networks’ true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 35% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company’s potential, but there is plenty more to consider. If you’d like to know more about Alpha Networks as a business, it’s important to be aware of any risks it’s facing. Case in point: We’ve spotted 1 warning sign for Alpha Networks you should be aware of.
Today we’ve zoomed in on a single data point to better understand the nature of Alpha Networks’ 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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