E. Bon Holdings' (HKG:599) Strong Earnings Are Of Good Quality

The subdued stock price reaction suggests that E. Bon Holdings Limited's (HKG:599) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

See our latest analysis for E. Bon Holdings

Examining Cashflow Against E. Bon 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, E. Bon Holdings had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of HK$63m during the period, dwarfing its reported profit of HK$9.02m. Given that E. Bon Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$63m would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

E. Bon Holdings' profit was reduced by unusual items worth HK$4.0m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect E. Bon Holdings to produce a higher profit next year, all else being equal.

Our Take On E. Bon Holdings' Profit Performance

In conclusion, both E. Bon Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think E. Bon Holdings' earnings potential is at least as good as it seems, and maybe even better! If you want to do dive deeper into E. Bon Holdings, you'd also look into what risks it is currently facing. Our analysis shows 3 warning signs for E. Bon Holdings (1 is potentially serious!) and we strongly recommend you look at them before investing.

Our examination of E. Bon Holdings has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.