Weak Statutory Earnings May Not Tell The Whole Story For Guangdong Guanghong HoldingsLtd (SZSE:000529)

Despite Guangdong Guanghong Holdings Co.,Ltd.'s (SZSE:000529) recent earnings report having lackluster headline numbers, the market responded positively. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

Check out our latest analysis for Guangdong Guanghong HoldingsLtd

Examining Cashflow Against Guangdong Guanghong HoldingsLtd'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. The ratio shows us how much a company's profit exceeds its FCF.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Guangdong Guanghong HoldingsLtd has an accrual ratio of 0.26 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥385m, in contrast to the aforementioned profit of CN¥206.2m. We also note that Guangdong Guanghong 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¥385m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Guangdong Guanghong HoldingsLtd's profit was boosted by unusual items worth CN¥7.8m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Guangdong Guanghong HoldingsLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Guangdong Guanghong HoldingsLtd's Profit Performance

Guangdong Guanghong HoldingsLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Guangdong Guanghong HoldingsLtd's statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 3 warning signs for Guangdong Guanghong HoldingsLtd (1 is a bit concerning!) and we strongly recommend you look at them before investing.

Our examination of Guangdong Guanghong HoldingsLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.