Tak Lee Machinery Holdings' (HKG:2102) Solid Earnings Have Been Accounted For Conservatively

The stock was sluggish on the back of Tak Lee Machinery Holdings Limited's (HKG:2102) recent earnings report. Our analysis suggests that there are some reasons for hope that investors should be aware of.

View our latest analysis for Tak Lee Machinery Holdings

Examining Cashflow Against Tak Lee Machinery Holdings' 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. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to July 2021, Tak Lee Machinery Holdings had an accrual ratio of -0.16. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of HK$112m in the last year, which was a lot more than its statutory profit of HK$52.6m. Tak Lee Machinery Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tak Lee Machinery Holdings.

Our Take On Tak Lee Machinery Holdings' Profit Performance

Tak Lee Machinery Holdings' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Tak Lee Machinery Holdings' statutory profit actually understates its earnings potential! The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. At Simply Wall St, we found 2 warning signs for Tak Lee Machinery Holdings and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Tak Lee Machinery Holdings' profit. But there are plenty of other ways to inform your opinion of a company. 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.

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.

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