Inswave Systems' (KOSDAQ:450520) Profits Appear To Have Quality Issues

Inswave Systems Co., Ltd.'s (KOSDAQ:450520) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Inswave Systems

A Closer Look At Inswave Systems' 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 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.

Over the twelve months to March 2024, Inswave Systems recorded an accrual ratio of 0.61. 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. Even though it reported a profit of ₩3.13b, a look at free cash flow indicates it actually burnt through ₩4.9b in the last year. As it happens we don't have the data on what Inswave Systems produced by way of free cashflow, the year before, which is a pity.

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

Our Take On Inswave Systems' Profit Performance

As we have made quite clear, we're a bit worried that Inswave Systems didn't back up the last year's profit with free cashflow. For this reason, we think that Inswave Systems' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 3 warning signs for Inswave Systems (1 is potentially serious) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Inswave Systems' profit. 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 with high insider ownership.

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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.