Tak Lee Machinery Holdings' (HKG:2102) Strong Earnings Are Of Good Quality

The subdued stock price reaction suggests that Tak Lee Machinery Holdings Limited's (HKG:2102) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

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A Closer Look At 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to January 2025, Tak Lee Machinery Holdings recorded an accrual ratio of -0.23. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of HK$100m during the period, dwarfing its reported profit of HK$12.6m. Given that Tak Lee Machinery Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$100m would seem to be a step in the right direction.

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

Happily for shareholders, Tak Lee Machinery Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Tak Lee Machinery Holdings' statutory profit actually understates its earnings potential! And the EPS is up 24% 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. So while earnings quality is important, it's equally important to consider the risks facing Tak Lee Machinery Holdings at this point in time. When we did our research, we found 3 warning signs for Tak Lee Machinery Holdings (1 is a bit concerning!) that we believe deserve your full 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 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.