Is There More To The Story Than Hanil Networks's (KOSDAQ:046110) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Hanil Networks (KOSDAQ:046110).

We like the fact that Hanil Networks made a profit of ₩7.65b on its revenue of ₩116.3b, in the last year. Happily, it has grown both its profit and revenue over the last three years (though we note its revenue is down over the last year).

View our latest analysis for Hanil Networks

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. Today, we'll discuss Hanil 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 Hanil Networks.

Examining Cashflow Against Hanil Networks' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 September 2020, Hanil Networks recorded an accrual ratio of -0.44. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₩34b during the period, dwarfing its reported profit of ₩7.65b. Hanil Networks' free cash flow improved over the last year, which is generally good to see.

Our Take On Hanil Networks' Profit Performance

Happily for shareholders, Hanil Networks produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Hanil Networks' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing Hanil Networks at this point in time. Case in point: We've spotted 1 warning sign for Hanil Networks you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Hanil Networks' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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