Here's Why We Think SEOHAN Const. & Eng.co.Ltd's (KOSDAQ:011370) Statutory Earnings Might Be Conservative

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing SEOHAN Const. & Eng.co.Ltd (KOSDAQ:011370).

It's good to see that over the last twelve months SEOHAN Const. & Eng.co.Ltd made a profit of ₩18.7b on revenue of ₩484.3b. The chart below shows that both revenue and profit have declined over the last three years.

See our latest analysis for SEOHAN Const. & Eng.co.Ltd

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. So today we'll look at what SEOHAN Const. & Eng.co.Ltd's cashflow and unusual items tell 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 SEOHAN Const. & Eng.co.Ltd.

Examining Cashflow Against SEOHAN Const. & Eng.co.Ltd'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. 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. 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. 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.

SEOHAN Const. & Eng.co.Ltd has an accrual ratio of -0.28 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 ₩83b in the last year, which was a lot more than its statutory profit of ₩18.7b. Given that SEOHAN Const. & Eng.co.Ltd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₩83b would seem to be a step in the right direction. 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.

The Impact Of Unusual Items On Profit

SEOHAN Const. & Eng.co.Ltd's profit was reduced by unusual items worth ₩3.4b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect SEOHAN Const. & Eng.co.Ltd to produce a higher profit next year, all else being equal.

Our Take On SEOHAN Const. & Eng.co.Ltd's Profit Performance

In conclusion, both SEOHAN Const. & Eng.co.Ltd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think SEOHAN Const. & Eng.co.Ltd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into SEOHAN Const. & Eng.co.Ltd, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for SEOHAN Const. & Eng.co.Ltd you should be mindful of and 1 of these makes us a bit uncomfortable.

Our examination of SEOHAN Const. & Eng.co.Ltd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.

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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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