Shareholders Will Be Pleased With The Quality of Hunan Investment GroupLtd's (SZSE:000548) Earnings

Even though Hunan Investment Group Co.,Ltd.'s (SZSE:000548) recent earnings release was robust, the market didn't seem to notice. Investors are probably missing some underlying factors which are encouraging for the future of the company.

See our latest analysis for Hunan Investment GroupLtd

Examining Cashflow Against Hunan Investment GroupLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2023, Hunan Investment GroupLtd had an accrual ratio of -0.15. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥371m, well over the CN¥148.7m it reported in profit. Hunan Investment GroupLtd did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. 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 Hunan Investment GroupLtd.

The Impact Of Unusual Items On Profit

Surprisingly, given Hunan Investment GroupLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥21m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. If Hunan Investment GroupLtd 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 Hunan Investment GroupLtd's Profit Performance

In conclusion, Hunan Investment GroupLtd's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. After taking into account all these factors, we think that Hunan Investment GroupLtd's statutory results are a decent reflection of its underlying earnings power. While we do think that it has a good earnings profile, that doesn't mean the company is cheap. Hunan Investment GroupLtd is growing its earnings, so it wouldn't be surprising if it had an above-average P/E ratio. You can find out by clicking here.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 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.