Mengtian Home Group's (SHSE:603216) Conservative Accounting Might Explain Soft Earnings

Mengtian Home Group Inc.'s (SHSE:603216) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

See our latest analysis for Mengtian Home Group

Examining Cashflow Against Mengtian Home Group'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.

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. 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 2024, Mengtian Home Group had an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥188m in the last year, which was a lot more than its statutory profit of CN¥97.5m. Mengtian Home Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mengtian Home Group.

Our Take On Mengtian Home Group's Profit Performance

Happily for shareholders, Mengtian Home Group produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Mengtian Home Group's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. If you'd like to know more about Mengtian Home Group as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Mengtian Home Group (1 shouldn't be ignored!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Mengtian Home Group'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.