We Think Sebo Manufacturing Engineering & Construction's (KOSDAQ:011560) Healthy Earnings Might Be Conservative

Investors signalled that they were pleased with Sebo Manufacturing, Engineering & Construction Corp.'s (KOSDAQ:011560) most recent earnings report. According to our analysis of the report, the strong headline profit numbers are supported by strong earnings fundamentals.

View our latest analysis for Sebo Manufacturing Engineering & Construction

Examining Cashflow Against Sebo Manufacturing Engineering & Construction'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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Sebo Manufacturing Engineering & Construction recorded an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of ₩63b during the period, dwarfing its reported profit of ₩36.2b. Sebo Manufacturing Engineering & Construction shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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 Sebo Manufacturing Engineering & Construction.

The Impact Of Unusual Items On Profit

Surprisingly, given Sebo Manufacturing Engineering & Construction's accrual ratio implied strong cash conversion, its paper profit was actually boosted by ₩4.5b in unusual items. 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Sebo Manufacturing Engineering & Construction 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 Sebo Manufacturing Engineering & Construction's Profit Performance

In conclusion, Sebo Manufacturing Engineering & Construction's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think that Sebo Manufacturing Engineering & Construction's profits are a reasonably conservative guide to its underlying profitability. If you'd like to know more about Sebo Manufacturing Engineering & Construction as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that Sebo Manufacturing Engineering & Construction has 2 warning signs and it would be unwise to ignore these.

Our examination of Sebo Manufacturing Engineering & Construction has focussed on certain factors that can make its earnings look better than they are. 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 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.