Impressive Earnings May Not Tell The Whole Story For SFK Construction Holdings (HKG:1447)

SFK Construction Holdings Limited's (HKG:1447) stock was strong after they recently reported robust earnings. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

See our latest analysis for SFK Construction Holdings

A Closer Look At SFK Construction Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, SFK Construction Holdings recorded an accrual ratio of 0.40. 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. Over the last year it actually had negative free cash flow of HK$59m, in contrast to the aforementioned profit of HK$25.3m. We saw that FCF was HK$97m a year ago though, so SFK Construction Holdings has at least been able to generate positive FCF in the past. One positive for SFK Construction Holdings shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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 SFK Construction Holdings.

Our Take On SFK Construction Holdings' Profit Performance

As we have made quite clear, we're a bit worried that SFK Construction Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that SFK Construction Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 35% EPS growth in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about SFK Construction Holdings as a business, it's important to be aware of any risks it's facing. For example, we've found that SFK Construction Holdings has 4 warning signs (3 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

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