Why WITHTECH's (KOSDAQ:348350) Soft Earnings Are Just The Beginning Of Its Problems

WITHTECH Co., LTD. (KOSDAQ:348350) recently posted soft earnings but shareholders didn't react strongly. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

Check out our latest analysis for WITHTECH

A Closer Look At WITHTECH's 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). 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

WITHTECH has an accrual ratio of 0.57 for the year to December 2023. As a general rule, that bodes poorly for future profitability. 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 ₩16b, in contrast to the aforementioned profit of ₩6.33b. We saw that FCF was ₩22b a year ago though, so WITHTECH has at least been able to generate positive FCF in the past. 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. One positive for WITHTECH shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that WITHTECH's profit was boosted by unusual items worth ₩722m 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that WITHTECH's positive unusual items were quite significant relative to its profit in the year 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 WITHTECH's Profit Performance

Summing up, WITHTECH 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 WITHTECH's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about WITHTECH as a business, it's important to be aware of any risks it's facing. Be aware that WITHTECH is showing 3 warning signs in our investment analysis and 1 of those is concerning...

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.