We Believe STraffic Co's (KOSDAQ:234300) Earnings Are A Poor Guide For Its Profitability

Even though STraffic Co,. Ltd (KOSDAQ:234300) posted strong earnings recently, the stock hasn't reacted in a large way. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

See our latest analysis for STraffic Co

Examining Cashflow Against STraffic Co'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. 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 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, STraffic Co had an accrual ratio of 0.55. 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. Even though it reported a profit of ₩16.6b, a look at free cash flow indicates it actually burnt through ₩20b in the last year. We also note that STraffic Co's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₩20b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. STraffic Co expanded the number of shares on issue by 5.7% over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of STraffic Co's EPS by clicking here.

A Look At The Impact Of STraffic Co's Dilution On Its Earnings Per Share (EPS)

STraffic Co was losing money three years ago. The good news is that profit was up 76% in the last twelve months. But EPS was less impressive, up only 70% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So STraffic Co shareholders will want to see that EPS figure continue to increase. 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.

Our Take On STraffic Co's Profit Performance

In conclusion, STraffic Co has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at STraffic Co's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into STraffic Co, you'd also look into what risks it is currently facing. Case in point: We've spotted 3 warning signs for STraffic Co you should be mindful of and 1 of these is significant.

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.