Shaky Earnings May Not Tell The Whole Story For Dayou A-TechLtd (KRX:002880)

Shareholders didn't appear too concerned by Dayou A-Tech Co.,Ltd's (KRX:002880) weak earnings. We did some analysis and found some concerning details beneath the statutory profit number.

View our latest analysis for Dayou A-TechLtd

A Closer Look At Dayou A-TechLtd'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'.

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. 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. 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 2023, Dayou A-TechLtd recorded an accrual ratio of 0.24. 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 ₩71b, in contrast to the aforementioned profit of ₩26.9b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₩71b, this year, indicates high risk. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dayou A-TechLtd.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Dayou A-TechLtd increased the number of shares on issue by 21% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Dayou A-TechLtd's EPS by clicking here.

A Look At The Impact Of Dayou A-TechLtd's Dilution On Its Earnings Per Share (EPS)

Three years ago, Dayou A-TechLtd lost money. Even looking at the last year, profit was still down 29%. Sadly, earnings per share fell further, down a full 30% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Dayou A-TechLtd's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Dayou A-TechLtd's profit was boosted by unusual items worth ₩8.2b in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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 Dayou A-TechLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Dayou A-TechLtd's Profit Performance

In conclusion, Dayou A-TechLtd's weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For all the reasons mentioned above, we think that, at a glance, Dayou A-TechLtd's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you'd like to know more about Dayou A-TechLtd as a business, it's important to be aware of any risks it's facing. Be aware that Dayou A-TechLtd is showing 6 warning signs in our investment analysis and 2 of those are a bit unpleasant...

Our examination of Dayou A-TechLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.