KHVATECLtd's (KOSDAQ:060720) Performance Raises Some Questions

We didn't see KHVATEC Co.,Ltd.'s (KOSDAQ:060720) stock surge when it reported robust earnings recently. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

See our latest analysis for KHVATECLtd

Zooming In On KHVATECLtd'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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 December 2023, KHVATECLtd recorded an accrual ratio of 0.41. 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 ₩37b, in contrast to the aforementioned profit of ₩36.0b. We saw that FCF was ₩25b a year ago though, so KHVATECLtd 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.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that KHVATECLtd's profit was boosted by unusual items worth ₩10b in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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, after all, that's exactly what the accounting terminology implies. KHVATECLtd had a rather significant contribution from unusual items relative to its profit 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 KHVATECLtd's Profit Performance

KHVATECLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue KHVATECLtd's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To that end, you should learn about the 2 warning signs we've spotted with KHVATECLtd (including 1 which is potentially serious).

Our examination of KHVATECLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.