The Strong Earnings Posted By Namuga (KOSDAQ:190510) Are A Good Indication Of The Strength Of The Business

Namuga Co., Ltd. (KOSDAQ:190510) just reported healthy earnings but the stock price didn't move much. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for Namuga

A Closer Look At Namuga'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Namuga recorded an accrual ratio of -0.15. 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 ₩30b during the period, dwarfing its reported profit of ₩21.3b. Namuga's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

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

Our Take On Namuga's Profit Performance

As we discussed above, Namuga has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Namuga's statutory profit actually understates its earnings potential! Furthermore, it has done a great job growing EPS 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. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. If you're interested we have a graphic representation of Namuga's balance sheet.

This note has only looked at a single factor that sheds light on the nature of Namuga's 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 with significant insider holdings to be useful.

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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.