Ecopro Hn's (KOSDAQ:383310) Problems Go Beyond Weak Profit

The market rallied behind Ecopro Hn. Co., Ltd.'s (KOSDAQ:383310) stock, leading do a rise in the share price after its recent weak earnings report. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

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Zooming In On Ecopro Hn'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

Ecopro Hn has an accrual ratio of 0.24 for the year to December 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of ₩22b despite its profit of ₩21.5b, mentioned above. We also note that Ecopro Hn's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩22b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Ecopro Hn issued 37% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Ecopro Hn's historical EPS growth by clicking on this link.

A Look At The Impact Of Ecopro Hn's Dilution On Its Earnings Per Share (EPS)

Ecopro Hn has improved its profit over the last three years, with an annualized gain of 25% in that time. Net profit actually dropped by 36% in the last year. But the EPS result was even worse, with the company recording a decline of 37%. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Ecopro Hn's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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.

Our Take On Ecopro Hn's Profit Performance

As it turns out, Ecopro Hn couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Ecopro Hn's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Ecopro Hn has 3 warning signs (2 are concerning!) that deserve your attention before going any further with your analysis.

Our examination of Ecopro Hn 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.