We Think That There Are Issues Underlying DongKoo Bio & Pharma's (KOSDAQ:006620) Earnings

Despite posting some strong earnings, the market for DongKoo Bio & Pharma Co., Ltd.'s (KOSDAQ:006620) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

See our latest analysis for DongKoo Bio & Pharma

Examining Cashflow Against DongKoo Bio & Pharma'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. 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. 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 December 2023, DongKoo Bio & Pharma recorded an accrual ratio of 0.21. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of ₩12b despite its profit of ₩11.8b, mentioned above. It's worth noting that DongKoo Bio & Pharma generated positive FCF of ₩5.7b a year ago, so at least they've done it in the past. However, that's not all there is to consider. 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 DongKoo Bio & Pharma.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by ₩1.3b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If DongKoo Bio & Pharma 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 DongKoo Bio & Pharma's Profit Performance

Summing up, DongKoo Bio & Pharma received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at DongKoo Bio & Pharma's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into DongKoo Bio & Pharma, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for DongKoo Bio & Pharma (1 shouldn't be ignored!) that we believe deserve your full attention.

Our examination of DongKoo Bio & Pharma has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.