Sangsangin Industry's (KOSDAQ:101000) Earnings Are Built On Soft Foundations

Sangsangin Industry Co., Ltd. (KOSDAQ:101000) posted some decent earnings, but shareholders didn't react strongly. Our analysis has found some concerning factors which weaken the profit's foundation.

View our latest analysis for Sangsangin Industry

Examining Cashflow Against Sangsangin Industry'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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Sangsangin Industry has an accrual ratio of 0.27 for the year to December 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of ₩6.5b, in contrast to the aforementioned profit of ₩1.41b. We also note that Sangsangin Industry's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩6.5b. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sangsangin Industry.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by ₩535m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. We can see that Sangsangin Industry's positive unusual items were quite significant relative to its profit in the year to December 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Sangsangin Industry's Profit Performance

Sangsangin Industry had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Sangsangin Industry's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Sangsangin Industry has 2 warning signs (and 1 which can't be ignored) we think you should know about.

Our examination of Sangsangin Industry has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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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