Are Heng Sheng Holding Group's (KOSDAQ:900270) Statutory Earnings A Good Guide To Its Underlying Profitability?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Heng Sheng Holding Group (KOSDAQ:900270).

We like the fact that Heng Sheng Holding Group made a profit of ₩19.0b on its revenue of ₩169.8b, in the last year. Below, you can see that both its revenue and its profit have fallen over the last three years.

View our latest analysis for Heng Sheng Holding Group

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. As a result, we think it's well worth considering what Heng Sheng Holding Group's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Heng Sheng Holding Group.

Examining Cashflow Against Heng Sheng Holding Group'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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Heng Sheng Holding Group has an accrual ratio of -0.14 for the year to September 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of ₩40b in the last year, which was a lot more than its statutory profit of ₩19.0b. Heng Sheng Holding Group's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On Heng Sheng Holding Group's Profit Performance

As we discussed above, Heng Sheng Holding Group has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Heng Sheng Holding Group's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 2 warning signs for Heng Sheng Holding Group you should be mindful of and 1 of these is potentially serious.

Today we've zoomed in on a single data point to better understand the nature of Heng Sheng Holding Group's profit. 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. 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.

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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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