Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Sun.King Power Electronics Group (HKG:580).
It’s good to see that over the last twelve months Sun.King Power Electronics Group made a profit of CN¥174.3m on revenue of CN¥1.46b. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.
Not all profits are equal, and we can learn more about the nature of a company’s past profitability by diving deeper into the financial statements. Today, we’ll discuss Sun.King Power Electronics Group’s free cashflow relative to its earnings, and consider what that tells us about the company. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
A Closer Look At Sun.King Power Electronics Group’s 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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Sun.King Power Electronics Group has an accrual ratio of 0.23 for the year to June 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥174.3m, a look at free cash flow indicates it actually burnt through CN¥166.7m in the last year. It’s worth noting that Sun.King Power Electronics Group generated positive FCF of CN¥65m a year ago, so at least they’ve done it in the past.
Our Take On Sun.King Power Electronics Group’s Profit Performance
Sun.King Power Electronics Group’s 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. Therefore, it seems possible to us that Sun.King Power Electronics Group’s true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. For instance, we’ve identified 3 warning signs for Sun.King Power Electronics Group (1 doesn’t sit too well with us) you should be familiar with.
Today we’ve zoomed in on a single data point to better understand the nature of Sun.King Power Electronics Group’s profit. But there are plenty of other ways to inform your opinion of a company. 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 that insiders are buying to be useful.
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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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