Hwasung Industrial's (KRX:002460) Shareholders May Want To Dig Deeper Than Statutory Profit

Hwasung Industrial Co., Ltd.'s (KRX:002460) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

View our latest analysis for Hwasung Industrial

Zooming In On Hwasung Industrial'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. 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 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".

Over the twelve months to December 2020, Hwasung Industrial recorded an accrual ratio of -0.35. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of ₩100b, well over the ₩33.2b it reported in profit. Hwasung Industrial's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Hwasung Industrial increased the number of shares on issue by 6.1% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Hwasung Industrial's EPS by clicking here.

A Look At The Impact Of Hwasung Industrial's Dilution on Its Earnings Per Share (EPS).

As you can see above, Hwasung Industrial has been growing its net income over the last few years, with an annualized gain of 109% over three years. And the 323% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 322% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Hwasung Industrial can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

How Do Unusual Items Influence Profit?

Surprisingly, given Hwasung Industrial's accrual ratio implied strong cash conversion, its paper profit was actually boosted by ₩7.8b in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Hwasung Industrial doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Hwasung Industrial's Profit Performance

Summing up, Hwasung Industrial's accrual ratio suggests that its statutory earnings are well matched by cash flow while its unusual items boosted the profit in a way that might not be repeated. Meanwhile, the dilution was a negative for shareholders. Based on these factors, we think it's very unlikely that Hwasung Industrial's statutory profits make it seem much weaker than it is. So while earnings quality is important, it's equally important to consider the risks facing Hwasung Industrial at this point in time. To help with this, we've discovered 4 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Hwasung Industrial.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there are plenty of other ways to inform your opinion of a company. 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.

If you’re looking to trade Hwasung Industrial, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.