Here's Why We Don't Think Daesung Microbiological Labs's (KOSDAQ:036480) Statutory Earnings Reflect Its Underlying Earnings Potential

Statistically speaking, it is less risky to invest in profitable companies than in 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 Daesung Microbiological Labs (KOSDAQ:036480).

It's good to see that over the last twelve months Daesung Microbiological Labs made a profit of ₩2.44b on revenue of ₩25.4b. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

Check out our latest analysis for Daesung Microbiological Labs

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 Daesung Microbiological Labs' 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 Daesung Microbiological Labs.

Zooming In On Daesung Microbiological Labs' 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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

Daesung Microbiological Labs has an accrual ratio of 0.36 for the year to September 2020. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of ₩10b, in contrast to the aforementioned profit of ₩2.44b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₩10b, this year, indicates high risk.

Our Take On Daesung Microbiological Labs' Profit Performance

As we discussed above, we think Daesung Microbiological Labs' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Daesung Microbiological Labs' underlying earnings power is lower 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. 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. Be aware that Daesung Microbiological Labs is showing 5 warning signs in our investment analysis and 3 of those are a bit concerning...

Today we've zoomed in on a single data point to better understand the nature of Daesung Microbiological Labs' 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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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