Does Chinyang Poly UrethaneLtd's (KRX:010640) Statutory Profit Adequately Reflect Its Underlying Profit?

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Chinyang Poly UrethaneLtd (KRX:010640).

It's good to see that over the last twelve months Chinyang Poly UrethaneLtd made a profit of ₩1.94b on revenue of ₩37.4b.

See our latest analysis for Chinyang Poly UrethaneLtd

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 Chinyang Poly UrethaneLtd'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 Chinyang Poly UrethaneLtd.

A Closer Look At Chinyang Poly UrethaneLtd'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. 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. 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".

For the year to September 2020, Chinyang Poly UrethaneLtd had an accrual ratio of 0.26. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of ₩1.94b, a look at free cash flow indicates it actually burnt through ₩6.0b in the last year. It's worth noting that Chinyang Poly UrethaneLtd generated positive FCF of ₩1.8b a year ago, so at least they've done it in the past.

Our Take On Chinyang Poly UrethaneLtd's Profit Performance

Chinyang Poly UrethaneLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Chinyang Poly UrethaneLtd's true underlying earnings power is actually less than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. If you'd like to know more about Chinyang Poly UrethaneLtd as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Chinyang Poly UrethaneLtd (of which 1 is a bit concerning!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Chinyang Poly UrethaneLtd'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. 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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