Here's Why We Think Jeongsan AikangLtd's (KOSDAQ:022220) Statutory Earnings Might Be Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Jeongsan AikangLtd's (KOSDAQ:022220) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Jeongsan AikangLtd made a profit of ₩4.28b on revenue of ₩59.3b. The chart below shows that both revenue and profit have declined over the last three years.

See our latest analysis for Jeongsan AikangLtd

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. As a result, today we're going to take a closer look at Jeongsan AikangLtd's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jeongsan AikangLtd.

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

For the year to September 2020, Jeongsan AikangLtd had an accrual ratio of -0.16. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of ₩13b in the last year, which was a lot more than its statutory profit of ₩4.28b. Jeongsan AikangLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

The Impact Of Unusual Items On Profit

Jeongsan AikangLtd's profit was reduced by unusual items worth ₩3.5b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. 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. Jeongsan AikangLtd took a rather significant hit from unusual items in the year to September 2020. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On Jeongsan AikangLtd's Profit Performance

Considering both Jeongsan AikangLtd's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Jeongsan AikangLtd's statutory profit probably understates its earnings potential! If you'd like to know more about Jeongsan AikangLtd as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Jeongsan AikangLtd you should know about.

Our examination of Jeongsan AikangLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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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