Chow Tai Seng Jewellery's (SZSE:002867) Solid Earnings May Rest On Weak Foundations

The market shrugged off Chow Tai Seng Jewellery Co., Ltd.'s (SZSE:002867) solid earnings report. We did some digging and believe investors may be worried about some underlying factors in the report.

See our latest analysis for Chow Tai Seng Jewellery

Zooming In On Chow Tai Seng Jewellery'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 March 2024, Chow Tai Seng Jewellery had an accrual ratio of 0.35. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of CN¥1.29b, a look at free cash flow indicates it actually burnt through CN¥400m in the last year. It's worth noting that Chow Tai Seng Jewellery generated positive FCF of CN¥908m a year ago, so at least they've done it in the past.

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.

Our Take On Chow Tai Seng Jewellery's Profit Performance

As we have made quite clear, we're a bit worried that Chow Tai Seng Jewellery didn't back up the last year's profit with free cashflow. For this reason, we think that Chow Tai Seng Jewellery's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 12% per annum growth in EPS for the last three. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Chow Tai Seng Jewellery is showing 2 warning signs in our investment analysis and 1 of those is potentially serious...

Today we've zoomed in on a single data point to better understand the nature of Chow Tai Seng Jewellery's profit. But there are plenty of other ways to inform your opinion of a company. 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.