Here's Why CHUNGDAHM Learning's (KOSDAQ:096240) Statutory Earnings Are Arguably Too Conservative

Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether CHUNGDAHM Learning's (KOSDAQ:096240) statutory profits are a good guide to its underlying earnings.

We like the fact that CHUNGDAHM Learning made a profit of ₩4.52b on its revenue of ₩178.8b, in the last year. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.

View our latest analysis for CHUNGDAHM Learning

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what CHUNGDAHM Learning's cashflow and unusual items tell us about the quality of its earnings, as well as touching on how its recent share issues are impacting shareholders. 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.

Zooming In On CHUNGDAHM Learning's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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".

CHUNGDAHM Learning has an accrual ratio of -0.29 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₩32b during the period, dwarfing its reported profit of ₩4.52b. CHUNGDAHM Learning shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, CHUNGDAHM Learning increased the number of shares on issue by 10% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of CHUNGDAHM Learning's EPS by clicking here.

How Is Dilution Impacting CHUNGDAHM Learning's Earnings Per Share? (EPS)

CHUNGDAHM Learning was losing money three years ago. Even looking at the last year, profit was still down 49%. Sadly, earnings per share fell further, down a full 51% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if CHUNGDAHM Learning's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

CHUNGDAHM Learning's profit was reduced by unusual items worth ₩6.7b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect CHUNGDAHM Learning to produce a higher profit next year, all else being equal.

Our Take On CHUNGDAHM Learning's Profit Performance

Summing up, CHUNGDAHM Learning's accrual ratio and its unusual items suggest that its statutory earnings were temporarily depressed (and could bounce back), while the dilution is a negative for shareholders. Based on these factors, we think CHUNGDAHM Learning's earnings potential is at least as good as it seems, and maybe even better! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 5 warning signs with CHUNGDAHM Learning, and understanding them should be part of your investment process.

After our examination into the nature of CHUNGDAHM Learning's profit, we've come away optimistic for the company. 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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