Here's Why We Don't Think Macau E&M Holding's (HKG:1408) Statutory Earnings Reflect Its Underlying Earnings Potential

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Macau E&M Holding (HKG:1408).

We like the fact that Macau E&M Holding made a profit of MO$40.4m on its revenue of MO$267.5m, in the last year.

View our latest analysis for Macau E&M Holding

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. Today, we'll discuss Macau E&M Holding's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Macau E&M Holding.

Examining Cashflow Against Macau E&M Holding's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2020, Macau E&M Holding recorded an accrual ratio of 0.70. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of MO$40.4m, a look at free cash flow indicates it actually burnt through MO$2.2m in the last year. We saw that FCF was MO$17m a year ago though, so Macau E&M Holding has at least been able to generate positive FCF in the past.

Our Take On Macau E&M Holding's Profit Performance

As we discussed above, we think Macau E&M Holding's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Macau E&M Holding's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 19% in the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, Macau E&M Holding has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Macau E&M 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 that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. 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.
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