Buyang International Holding's (HKG:2457) Anemic Earnings Might Be Worse Than You Think

The subdued market reaction suggests that Buyang International Holding Inc's (HKG:2457) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Buyang International Holding

A Closer Look At Buyang International Holding'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.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Buyang International Holding has an accrual ratio of 0.36 for the year to June 2024. 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¥37.1m, a look at free cash flow indicates it actually burnt through CN¥30m in the last year. It's worth noting that Buyang International Holding generated positive FCF of CN¥68m a year ago, so at least they've done it in the past. The good news for shareholders is that Buyang International Holding's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Buyang International Holding.

Our Take On Buyang International Holding's Profit Performance

As we have made quite clear, we're a bit worried that Buyang International Holding didn't back up the last year's profit with free cashflow. For this reason, we think that Buyang International Holding's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. 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 Buyang International Holding (1 shouldn't be ignored!) and we strongly recommend you look at them before investing.

Today we've zoomed in on a single data point to better understand the nature of Buyang International Holding's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.