Samsung Engineering (KRX:028050) Is Growing Earnings But Are They A Good Guide?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Samsung Engineering's (KRX:028050) statutory profits are a good guide to its underlying earnings.

We like the fact that Samsung Engineering made a profit of ₩255.5b on its revenue of ₩6.63t, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

View our latest analysis for Samsung Engineering

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 Samsung Engineering's cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

A Closer Look At Samsung Engineering'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Samsung Engineering has an accrual ratio of 0.36 for the year to September 2020. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of ₩255.5b, a look at free cash flow indicates it actually burnt through ₩92b in the last year. It's worth noting that Samsung Engineering generated positive FCF of ₩867b a year ago, so at least they've done it in the past. The good news for shareholders is that Samsung Engineering's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On Samsung Engineering's Profit Performance

As we discussed above, we think Samsung Engineering's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Samsung Engineering's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Samsung Engineering, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 2 warning signs for Samsung Engineering (of which 1 doesn't sit too well with us!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Samsung Engineering's profit. 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. 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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