Does POSCO COATED & COLOR STEEL's (KRX:058430) Statutory Profit Adequately Reflect Its Underlying Profit?

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. In this article, we'll look at how useful this year's statutory profit is, when analysing POSCO COATED & COLOR STEEL (KRX:058430).

It's good to see that over the last twelve months POSCO COATED & COLOR STEEL made a profit of ₩4.51b on revenue of ₩897.4b. The chart below shows that revenue has been flat over the last three years, while profit has actually declined.

View our latest analysis for POSCO COATED & COLOR STEEL

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. As a result, we think it's well worth considering what POSCO COATED & COLOR STEEL'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 POSCO COATED & COLOR STEEL.

Examining Cashflow Against POSCO COATED & COLOR STEEL's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 September 2020, POSCO COATED & COLOR STEEL had an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of ₩60b during the period, dwarfing its reported profit of ₩4.51b. Given that POSCO COATED & COLOR STEEL had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₩60b would seem to be a step in the right direction.

Our Take On POSCO COATED & COLOR STEEL's Profit Performance

As we discussed above, POSCO COATED & COLOR STEEL's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think POSCO COATED & COLOR STEEL's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 4 warning signs for POSCO COATED & COLOR STEEL (1 is concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of POSCO COATED & COLOR STEEL'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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