Are AhnLab's (KOSDAQ:053800) Statutory Earnings A Good Guide To Its Underlying Profitability?

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. In this article, we'll look at how useful this year's statutory profit is, when analysing AhnLab (KOSDAQ:053800).

We like the fact that AhnLab made a profit of ₩20.0b on its revenue of ₩170.7b, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

See our latest analysis for AhnLab

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. As a result, we think it's well worth considering what AhnLab's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of AhnLab.

Examining Cashflow Against AhnLab'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 September 2020, AhnLab recorded an accrual ratio of -0.18. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of ₩31b during the period, dwarfing its reported profit of ₩20.0b. AhnLab's free cash flow improved over the last year, which is generally good to see.

Our Take On AhnLab's Profit Performance

As we discussed above, AhnLab's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that AhnLab's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 15% per year over the last three years. 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. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you're interested we have a graphic representation of AhnLab's balance sheet.

Today we've zoomed in on a single data point to better understand the nature of AhnLab's 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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