Broadly speaking, profitable businesses are less risky than unprofitable ones. 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 Digital Imaging Technology (KOSDAQ:110990).
It’s good to see that over the last twelve months Digital Imaging Technology made a profit of ₩8.01b on revenue of ₩85.8b. The chart below shows how it has grown revenue over the last three years, but that profit has declined.
Check out our latest analysis for Digital Imaging Technology
Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we’ll discuss Digital Imaging Technology’s free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Digital Imaging Technology.
Zooming In On Digital Imaging Technology’s 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. You could think of the accrual ratio from cashflow as the ‘non-FCF profit ratio’.
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. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
For the year to March 2020, Digital Imaging Technology had an accrual ratio of 0.47. Statistically speaking, that’s a real negative for future earnings. And indeed, during the period the company didn’t produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₩9.9b, in contrast to the aforementioned profit of ₩8.01b. We saw that FCF was ₩5.4b a year ago though, so Digital Imaging Technology has at least been able to generate positive FCF in the past.
Our Take On Digital Imaging Technology’s Profit Performance
As we discussed above, we think Digital Imaging Technology’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 Digital Imaging Technology’s underlying earnings power is lower than its statutory profit. And we are pleased to note that EPS is at least heading in the right direction in the alst twelve months. 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. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. Our analysis shows 3 warning signs for Digital Imaging Technology (2 can’t be ignored!) and we strongly recommend you look at these before investing.
Today we’ve zoomed in on a single data point to better understand the nature of Digital Imaging Technology’s profit. But there are plenty of other ways to inform your opinion of a company. 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.
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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.
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