We Think That There Are Some Issues For Hengbo HoldingsLtd (SZSE:301225) Beyond Its Promising Earnings

The recent earnings posted by Hengbo Holdings Co.,Ltd. (SZSE:301225) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

See our latest analysis for Hengbo HoldingsLtd

A Closer Look At Hengbo HoldingsLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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.

For the year to March 2024, Hengbo HoldingsLtd had an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥19m despite its profit of CN¥115.8m, mentioned above. We also note that Hengbo HoldingsLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥19m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hengbo HoldingsLtd.

Our Take On Hengbo HoldingsLtd's Profit Performance

Hengbo HoldingsLtd'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. Because of this, we think that it may be that Hengbo HoldingsLtd's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 24% over the last three years. 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 while earnings quality is important, it's equally important to consider the risks facing Hengbo HoldingsLtd at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Hengbo HoldingsLtd.

Today we've zoomed in on a single data point to better understand the nature of Hengbo HoldingsLtd's profit. 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. 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.