We Think CHOSUN WELDING POHANG's (KRX:120030) Solid Earnings Are Understated

The market seemed underwhelmed by last week's earnings announcement from CHOSUN WELDING POHANG Co., Ltd (KRX:120030) despite the healthy numbers. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

See our latest analysis for CHOSUN WELDING POHANG

Zooming In On CHOSUN WELDING POHANG'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. 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. 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.

Over the twelve months to March 2024, CHOSUN WELDING POHANG recorded an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of ₩21b, well over the ₩12.2b it reported in profit. CHOSUN WELDING POHANG's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of CHOSUN WELDING POHANG.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that CHOSUN WELDING POHANG's profit was boosted by unusual items worth ₩690m 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If CHOSUN WELDING POHANG doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On CHOSUN WELDING POHANG's Profit Performance

In conclusion, CHOSUN WELDING POHANG's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that CHOSUN WELDING POHANG's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing CHOSUN WELDING POHANG at this point in time. For example, CHOSUN WELDING POHANG has 2 warning signs (and 1 which is concerning) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.