Should You Rely On KPa-BM Holdings's (HKG:2663) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether KPa-BM Holdings' (HKG:2663) statutory profits are a good guide to its underlying earnings.

While KPa-BM Holdings was able to generate revenue of HK$551.0m in the last twelve months, we think its profit result of HK$50.9m was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its revenue is down over the last year).

See our latest analysis for KPa-BM Holdings

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. Today, we'll discuss KPa-BM Holdings' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of KPa-BM Holdings.

A Closer Look At KPa-BM 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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 September 2020, KPa-BM Holdings recorded an accrual ratio of -0.58. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of HK$122m in the last year, which was a lot more than its statutory profit of HK$50.9m. KPa-BM Holdings' free cash flow improved over the last year, which is generally good to see.

Our Take On KPa-BM Holdings' Profit Performance

Happily for shareholders, KPa-BM Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that KPa-BM Holdings' statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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. 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. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of KPa-BM Holdings.

Today we've zoomed in on a single data point to better understand the nature of KPa-BM 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. 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. 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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