DRGEM (KOSDAQ:263690) Is Growing Earnings But Are They A Good Guide?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding DRGEM (KOSDAQ:263690).

It's good to see that over the last twelve months DRGEM made a profit of ₩20.5b on revenue of ₩101.9b. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for DRGEM

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what DRGEM'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 DRGEM.

Zooming In On DRGEM'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. 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. 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".

For the year to September 2020, DRGEM had an accrual ratio of 0.34. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Indeed, in the last twelve months it reported free cash flow of ₩8.4b, which is significantly less than its profit of ₩20.5b. Notably, DRGEM had negative free cash flow last year, so the ₩8.4b it produced this year was a welcome improvement.

Our Take On DRGEM's Profit Performance

As we discussed above, we think DRGEM's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that DRGEM's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Our analysis shows 2 warning signs for DRGEM (1 is a bit concerning!) and we strongly recommend you look at them before investing.

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