Statutory Profit Doesn't Reflect How Good HSD Engine's (KRX:082740) Earnings Are

HSD Engine Co., Ltd. (KRX:082740) recently posted some strong earnings, and the market responded positively. Our analysis found some more factors that we think are good for shareholders.

View our latest analysis for HSD Engine

A Closer Look At HSD Engine's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

HSD Engine has an accrual ratio of -0.20 for the year to December 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₩80b, well over the ₩6.05b it reported in profit. Notably, HSD Engine had negative free cash flow last year, so the ₩80b it produced this year was a welcome improvement.

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.

Our Take On HSD Engine's Profit Performance

Happily for shareholders, HSD Engine produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think HSD Engine's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And one can definitely find a positive in the fact that it made a profit this year, despite losing money last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 1 warning sign with HSD Engine, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of HSD Engine's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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