Weak Statutory Earnings May Not Tell The Whole Story For Da-Cin ConstructionLtd (TWSE:2535)

Da-Cin Construction Co.,Ltd.'s (TWSE:2535) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for Da-Cin ConstructionLtd

Zooming In On Da-Cin ConstructionLtd'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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 September 2024, Da-Cin ConstructionLtd recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of NT$1.3b, in contrast to the aforementioned profit of NT$1.24b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of NT$1.3b, this year, indicates high risk. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Da-Cin ConstructionLtd.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by NT$216m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Da-Cin ConstructionLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Da-Cin ConstructionLtd's Profit Performance

Da-Cin ConstructionLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Da-Cin ConstructionLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Da-Cin ConstructionLtd, you'd also look into what risks it is currently facing. For example, we've found that Da-Cin ConstructionLtd has 2 warning signs (1 is potentially serious!) that deserve your attention before going any further with your analysis.

Our examination of Da-Cin ConstructionLtd 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 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. 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.