We’re Not So Sure You Should Rely on Wing Fung Group Asia’s (HKG:8526) Statutory Earnings

Broadly speaking, profitable businesses are less risky than 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. This article will consider whether Wing Fung Group Asia‘s (HKG:8526) statutory profits are a good guide to its underlying earnings.

It’s good to see that over the last twelve months Wing Fung Group Asia made a profit of HK$14.8m on revenue of HK$199.1m. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

View our latest analysis for Wing Fung Group Asia

SEHK:8526 Income Statement, January 30th 2020
SEHK:8526 Income Statement, January 30th 2020

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. As a result, we’ll today take a look at how dilution and cashflow shape our understanding of Wing Fung Group Asia’s earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wing Fung Group Asia.

A Closer Look At Wing Fung Group Asia’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. 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. The ratio shows us how much a company’s profit exceeds its FCF.

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 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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2019, Wing Fung Group Asia had an accrual ratio of 0.25. Therefore, we know that it’s free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Indeed, in the last twelve months it reported free cash flow of HK$1.8m, which is significantly less than its profit of HK$14.8m. Notably, Wing Fung Group Asia had negative free cash flow last year, so the HK$1.8m it produced this year was a welcome improvement. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Wing Fung Group Asia increased the number of shares on issue by 11% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company’s profits, while the net income level gives us a better view of the company’s absolute size. Check out Wing Fung Group Asia’s historical EPS growth by clicking on this link.

How Is Dilution Impacting Wing Fung Group Asia’s Earnings Per Share? (EPS)

Unfortunately, Wing Fung Group Asia’s profit is down 4.1% per year over three years. On the bright side, in the last twelve months it grew profit by 100%. But EPS was less impressive, up only 80% in that time. So you can see that the dilution has had a bit of an impact on shareholders.Therefore, the dilution is having a noteworthy influence on shareholder returnsAnd so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So Wing Fung Group Asia shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company’s share price might grow.

Our Take On Wing Fung Group Asia’s Profit Performance

As it turns out, Wing Fung Group Asia couldn’t match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we’d argue Wing Fung Group Asia’s profits probably give an overly generous impression of its sustainable level of profitability. While earnings are important, another area to consider is the balance sheet. If you’re interestedwe have a graphic representation of Wing Fung Group Asia’s balance sheet.

Our examination of Wing Fung Group Asia 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. Some people consider a high return on equity to be a good sign of a quality business. 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 spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.