NaintechLTD's (KOSDAQ:267320) Attractive Earnings Are Not All Good News For Shareholders

After announcing healthy earnings, Naintech CO.,LTD.'s (KOSDAQ:267320) stock rose over the last week. While the headline numbers were strong, we found some underlying problems once we started looking at what drove earnings.

Check out our latest analysis for NaintechLTD

Zooming In On NaintechLTD'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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".

For the year to September 2024, NaintechLTD had an accrual ratio of 0.32. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of ₩20.8b, a look at free cash flow indicates it actually burnt through ₩17b in the last year. We also note that NaintechLTD's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩17b. 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 NaintechLTD.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that NaintechLTD's profit was boosted by unusual items worth ₩524m in the last twelve months. 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 NaintechLTD's positive unusual items were quite significant relative to its profit in the year to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On NaintechLTD's Profit Performance

Summing up, NaintechLTD received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at NaintechLTD's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into NaintechLTD, you'd also look into what risks it is currently facing. Our analysis shows 2 warning signs for NaintechLTD (1 shouldn't be ignored!) and we strongly recommend you look at these before investing.

Our examination of NaintechLTD 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 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. 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.