SEWON Precision Industry's (KRX:021820) Earnings Aren't As Good As They Appear

We didn't see SEWON Precision Industry Co., Ltd.'s (KRX:021820) stock surge when it reported robust earnings recently. We think that investors might be worried about the foundations the earnings are built on.

See our latest analysis for SEWON Precision Industry

Examining Cashflow Against SEWON Precision Industry's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 June 2024, SEWON Precision Industry recorded an accrual ratio of 0.27. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of ₩44b, in contrast to the aforementioned profit of ₩55.4b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₩44b, this year, indicates high risk. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of SEWON Precision Industry.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that SEWON Precision Industry's profit was boosted by unusual items worth ₩19b 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. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. SEWON Precision Industry had a rather significant contribution from unusual items relative to its profit to June 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On SEWON Precision Industry's Profit Performance

Summing up, SEWON Precision Industry received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue SEWON Precision Industry's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into SEWON Precision Industry, you'd also look into what risks it is currently facing. For example, SEWON Precision Industry has 3 warning signs (and 1 which is significant) we think you should know about.

Our examination of SEWON Precision Industry 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 are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.