Why Build King Holdings' (HKG:240) Shaky Earnings Are Just The Beginning Of Its Problems

A lackluster earnings announcement from Build King Holdings Limited (HKG:240) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Build King Holdings

Zooming In On Build King Holdings' 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. 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'.

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. 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 December 2021, Build King Holdings had an accrual ratio of 2.01. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of HK$294.5m, a look at free cash flow indicates it actually burnt through HK$280m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$280m, this year, indicates high risk.

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

Our Take On Build King Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Build King Holdings didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Build King Holdings' underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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 while earnings quality is important, it's equally important to consider the risks facing Build King Holdings at this point in time. For example, Build King Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Build King 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.

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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.