We Don’t Think HB TechnologyLTD's (KOSDAQ:078150) Earnings Should Make Shareholders Too Comfortable

Solid profit numbers didn't seem to be enough to please HB Technology CO.,LTD.'s (KOSDAQ:078150) shareholders. Our analysis has found some concerning factors which weaken the profit's foundation.

View our latest analysis for HB TechnologyLTD

Examining Cashflow Against HB TechnologyLTD'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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2023, HB TechnologyLTD had an accrual ratio of 0.37. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of ₩22b despite its profit of ₩79.3b, mentioned above. We also note that HB TechnologyLTD's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩22b. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of HB TechnologyLTD.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, HB TechnologyLTD increased the number of shares on issue by 18% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of HB TechnologyLTD's EPS by clicking here.

How Is Dilution Impacting HB TechnologyLTD's Earnings Per Share (EPS)?

HB TechnologyLTD has improved its profit over the last three years, with an annualized gain of 2,109% in that time. In comparison, earnings per share only gained 1,995% over the same period. And the 191% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 175% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if HB TechnologyLTD can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that HB TechnologyLTD's profit was boosted by unusual items worth ₩103b 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. HB TechnologyLTD had a rather significant contribution from unusual items relative to its profit to December 2023. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On HB TechnologyLTD's Profit Performance

HB TechnologyLTD didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. The dilution means the results are weaker when viewed from a per-share perspective. For all the reasons mentioned above, we think that, at a glance, HB TechnologyLTD's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you'd like to know more about HB TechnologyLTD as a business, it's important to be aware of any risks it's facing. For example, HB TechnologyLTD has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Our examination of HB TechnologyLTD 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.