We Think You Can Look Beyond Hongrun Construction Group's (SZSE:002062) Lackluster Earnings

The most recent earnings report from Hongrun Construction Group Co., Ltd. (SZSE:002062) was disappointing for shareholders. However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

Check out our latest analysis for Hongrun Construction Group

Zooming In On Hongrun Construction Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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.

Over the twelve months to December 2023, Hongrun Construction Group recorded an accrual ratio of -0.10. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of CN¥785m during the period, dwarfing its reported profit of CN¥339.1m. Hongrun Construction Group did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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

Our Take On Hongrun Construction Group's Profit Performance

Hongrun Construction Group's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Hongrun Construction Group's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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 Hongrun Construction Group as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Hongrun Construction Group, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Hongrun Construction Group's profit. 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.

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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.