Impressive Earnings May Not Tell The Whole Story For Hock Lian Seng Holdings (SGX:J2T)

Despite posting some strong earnings, the market for Hock Lian Seng Holdings Limited's (SGX:J2T) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

Check out our latest analysis for Hock Lian Seng Holdings

Examining Cashflow Against Hock Lian Seng Holdings' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Hock Lian Seng Holdings has an accrual ratio of 0.30 for the year to December 2023. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of S$26.6m, a look at free cash flow indicates it actually burnt through S$6.9m in the last year. It's worth noting that Hock Lian Seng Holdings generated positive FCF of S$50m a year ago, so at least they've done it in the past. The good news for shareholders is that Hock Lian Seng Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hock Lian Seng Holdings.

Our Take On Hock Lian Seng Holdings' Profit Performance

Hock Lian Seng Holdings' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Hock Lian Seng Holdings' statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Hock Lian Seng Holdings is showing 2 warning signs in our investment analysis and 1 of those is significant...

This note has only looked at a single factor that sheds light on the nature of Hock Lian Seng Holdings' 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. 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.