Freewon ChinaLtd's (SHSE:688678) Shareholders May Want To Dig Deeper Than Statutory Profit

The market shrugged off Freewon China Co.,Ltd.'s (SHSE:688678) solid earnings report. We did some digging and believe investors may be worried about some underlying factors in the report.

View our latest analysis for Freewon ChinaLtd

Examining Cashflow Against Freewon ChinaLtd'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

For the year to September 2024, Freewon ChinaLtd had an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥103.5m, a look at free cash flow indicates it actually burnt through CN¥363m in the last year. We also note that Freewon ChinaLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥363m. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥13m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Freewon ChinaLtd's Profit Performance

Freewon ChinaLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Freewon ChinaLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Freewon ChinaLtd, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 2 warning signs for Freewon ChinaLtd (of which 1 doesn't sit too well with us!) you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 with high insider ownership.

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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.