Are Nam Hwa ConstructionLtd's (KOSDAQ:091590) Statutory Earnings A Good Guide To Its Underlying Profitability?

Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Nam Hwa ConstructionLtd (KOSDAQ:091590).

We like the fact that Nam Hwa ConstructionLtd made a profit of ₩5.43b on its revenue of ₩65.7b, in the last year. Below, you can see that both its revenue and its profit have fallen over the last three years.

See our latest analysis for Nam Hwa ConstructionLtd

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Nam Hwa ConstructionLtd's cashflow tells 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 Nam Hwa ConstructionLtd.

Examining Cashflow Against Nam Hwa ConstructionLtd'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.

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.

Nam Hwa ConstructionLtd has an accrual ratio of -0.11 for the year to September 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of ₩17b during the period, dwarfing its reported profit of ₩5.43b. Notably, Nam Hwa ConstructionLtd had negative free cash flow last year, so the ₩17b it produced this year was a welcome improvement.

Our Take On Nam Hwa ConstructionLtd's Profit Performance

Nam Hwa ConstructionLtd's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Nam Hwa ConstructionLtd's statutory profit actually understates its earnings potential! Furthermore, it has done a great job growing EPS over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. While earnings are important, another area to consider is the balance sheet. We've done some analysis and you can see our take on Nam Hwa ConstructionLtd's balance sheet by clicking here.

Today we've zoomed in on a single data point to better understand the nature of Nam Hwa ConstructionLtd's profit. 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 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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