We Think Welcron HantecLtd's (KOSDAQ:076080) Statutory Profit Might Understate Its Earnings Potential

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Welcron HantecLtd's (KOSDAQ:076080) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Welcron HantecLtd made a profit of ₩3.70b on revenue of ₩229.6b.

See our latest analysis for Welcron HantecLtd

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. Therefore, we think it's worth taking a closer look at Welcron HantecLtd's cashflow, as well as examining the impact that unusual items have had on its reported profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Welcron HantecLtd.

Examining Cashflow Against Welcron HantecLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

Welcron HantecLtd has an accrual ratio of -0.14 for the year to September 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of ₩12b, well over the ₩3.70b it reported in profit. Welcron HantecLtd 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.

The Impact Of Unusual Items On Profit

Welcron HantecLtd's profit was reduced by unusual items worth ₩4.9b 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. In the twelve months to September 2020, Welcron HantecLtd had a big unusual items expense. 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 Welcron HantecLtd's Profit Performance

Considering both Welcron HantecLtd's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Welcron HantecLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've discovered 4 warning signs that you should run your eye over to get a better picture of Welcron HantecLtd.

After our examination into the nature of Welcron HantecLtd's profit, we've come away optimistic for the company. 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. 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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