Hebei Construction Group's (HKG:1727) Shareholders Have More To Worry About Than Only Soft Earnings

A lackluster earnings announcement from Hebei Construction Group Corporation Limited (HKG:1727) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Hebei Construction Group

Zooming In On Hebei Construction Group's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Hebei Construction Group has an accrual ratio of 0.42 for the year to December 2023. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥1.4b despite its profit of CN¥171.4m, mentioned above. We also note that Hebei Construction Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.4b.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hebei Construction Group.

Our Take On Hebei Construction Group's Profit Performance

As we have made quite clear, we're a bit worried that Hebei Construction Group didn't back up the last year's profit with free cashflow. For this reason, we think that Hebei Construction Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. When we did our research, we found 3 warning signs for Hebei Construction Group (2 don't sit too well with us!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Hebei Construction Group's 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.