As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. This article will consider whether Golden Faith Group Holdings’ (HKG:2863) statutory profits are a good guide to its underlying earnings.
While Golden Faith Group Holdings was able to generate revenue of HK$414.5m in the last twelve months, we think its profit result of HK$20.1m was more important. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.
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. As a result, we’ll today take a look at how dilution and cashflow shape our understanding of Golden Faith Group Holdings’ earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Golden Faith Group Holdings.
Examining Cashflow Against Golden Faith Group 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. 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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to March 2020, Golden Faith Group Holdings had an accrual ratio of -0.94. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of HK$72m, well over the HK$20.1m it reported in profit. Notably, Golden Faith Group Holdings had negative free cash flow last year, so the HK$72m it produced this year was a welcome improvement. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.
One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Golden Faith Group Holdings issued 18% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Golden Faith Group Holdings’ historical EPS growth by clicking on this link.
How Is Dilution Impacting Golden Faith Group Holdings’ Earnings Per Share? (EPS)
Unfortunately, Golden Faith Group Holdings’ profit is down 22% per year over three years. The good news is that profit was up 9.4% in the last twelve months. On the other hand, earnings per share are only up 8.8% over the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.
Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Golden Faith Group Holdings shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company’s share price might grow.
Our Take On Golden Faith Group Holdings’ Profit Performance
In conclusion, Golden Faith Group Holdings has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Based on these factors, we think that Golden Faith Group Holdings’ profits are a reasonably conservative guide to its underlying profitability. If you’d like to know more about Golden Faith Group Holdings as a business, it’s important to be aware of any risks it’s facing. Case in point: We’ve spotted 4 warning signs for Golden Faith Group Holdings you should be mindful of and 1 of them is a bit concerning.
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to ‘follow the money’ and search out stocks that insiders are buying. 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. 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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