Are MegaMD's (KOSDAQ:133750) Statutory Earnings A Good Guide To Its Underlying Profitability?

Statistically speaking, it is less risky to invest in profitable companies than in 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. In this article, we'll look at how useful this year's statutory profit is, when analysing MegaMD (KOSDAQ:133750).

It's good to see that over the last twelve months MegaMD made a profit of ₩2.77b on revenue of ₩80.0b.

Check out our latest analysis for MegaMD

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. So today we'll look at what MegaMD's cashflow and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of MegaMD.

Examining Cashflow Against MegaMD'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2020, MegaMD had an accrual ratio of -0.29. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of ₩13b during the period, dwarfing its reported profit of ₩2.77b. MegaMD's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that MegaMD's profit was boosted by unusual items worth ₩1.2b in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. MegaMD had a rather significant contribution from unusual items relative to its profit to June 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On MegaMD's Profit Performance

MegaMD's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if MegaMD's profits are a reasonable reflection of its underlying profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 5 warning signs we've spotted with MegaMD (including 1 which is significant).

Our examination of MegaMD has focussed on certain factors that can make its earnings look better than they are. 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. 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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