We Think You Should Be Aware Of Some Concerning Factors In Focus Hotmelt's (SZSE:301283) Earnings

The stock price didn't jump after Focus Hotmelt Company Ltd. (SZSE:301283) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.

Check out our latest analysis for Focus Hotmelt

A Closer Look At Focus Hotmelt'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. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Focus Hotmelt has an accrual ratio of 0.39 for the year to September 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥262m despite its profit of CN¥95.7m, mentioned above. We also note that Focus Hotmelt's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥262m.

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 Focus Hotmelt's Profit Performance

As we discussed above, we think Focus Hotmelt's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Focus Hotmelt's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Nonetheless, it's still worth noting that its earnings per share have grown at 18% over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For instance, we've identified 2 warning signs for Focus Hotmelt (1 doesn't sit too well with us) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Focus Hotmelt'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. 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 with significant insider holdings 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.