Beyond Lackluster Earnings: Potential Concerns For Daewoo Engineering & Construction's (KRX:047040) Shareholders

After announcing weak earnings, Daewoo Engineering & Construction Co., Ltd.'s (KRX:047040) stock was strong. While shares were up, we believe there are some factors in the earnings report that might cause investors some concerns.

Check out our latest analysis for Daewoo Engineering & Construction

Zooming In On Daewoo Engineering & Construction'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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Daewoo Engineering & Construction has an accrual ratio of 0.40 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₩327.8b, a look at free cash flow indicates it actually burnt through ₩1.8t in the last year. We also note that Daewoo Engineering & Construction's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩1.8t. 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.

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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by ₩45b, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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 Daewoo Engineering & Construction 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 Daewoo Engineering & Construction's Profit Performance

Daewoo Engineering & Construction had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Daewoo Engineering & Construction's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for Daewoo Engineering & Construction you should be aware of.

Our examination of Daewoo Engineering & Construction 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. 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 with significant insider holdings to be useful.

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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.