We Wouldn't Rely On Korea Electric Power Industrial Development's (KRX:130660) Statutory Earnings As A Guide

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Korea Electric Power Industrial Development (KRX:130660).

While Korea Electric Power Industrial Development was able to generate revenue of ₩332.6b in the last twelve months, we think its profit result of ₩16.4b was more important. The chart below shows that revenue has been pretty flat over the last three years, but profit has increased.

See our latest analysis for Korea Electric Power Industrial Development

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Korea Electric Power Industrial Development's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Korea Electric Power Industrial Development.

Examining Cashflow Against Korea Electric Power Industrial Development'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Korea Electric Power Industrial Development has an accrual ratio of 0.37 for the year to September 2020. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₩7.4b despite its profit of ₩16.4b, mentioned above. It's worth noting that Korea Electric Power Industrial Development generated positive FCF of ₩12b a year ago, so at least they've done it in the past.

Our Take On Korea Electric Power Industrial Development's Profit Performance

As we discussed above, we think Korea Electric Power Industrial Development's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Korea Electric Power Industrial Development's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 44% per annum growth in EPS for the last three. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 3 warning signs for Korea Electric Power Industrial Development (2 can't be ignored!) and we strongly recommend you look at these bad boys before investing.

This note has only looked at a single factor that sheds light on the nature of Korea Electric Power Industrial Development's 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 that insiders are buying.

If you decide to trade Korea Electric Power Industrial Development, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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