We Think Samhwa Networks's (KOSDAQ:046390) Statutory Profit Might Understate Its Earnings Potential

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Samhwa Networks (KOSDAQ:046390).

It's good to see that over the last twelve months Samhwa Networks made a profit of ₩2.07b on revenue of ₩33.1b.

View our latest analysis for Samhwa Networks

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Samhwa Networks' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Samhwa Networks.

Examining Cashflow Against Samhwa Networks' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2020, Samhwa Networks recorded an accrual ratio of -0.40. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₩8.5b, well over the ₩2.07b it reported in profit. Notably, Samhwa Networks had negative free cash flow last year, so the ₩8.5b it produced this year was a welcome improvement.

Our Take On Samhwa Networks' Profit Performance

Happily for shareholders, Samhwa Networks produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Samhwa Networks' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example - Samhwa Networks has 1 warning sign we think you should be aware of.

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