Is There More To The Story Than North Asia Strategic Holdings' (HKG:8080) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether North Asia Strategic Holdings' (HKG:8080) statutory profits are a good guide to its underlying earnings.

We like the fact that North Asia Strategic Holdings made a profit of HK$133.6m on its revenue of HK$2.50b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its revenue has slipped in the last twelve months.

See our latest analysis for North Asia Strategic Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what North Asia Strategic Holdings' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of North Asia Strategic Holdings.

Zooming In On North Asia Strategic Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

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. 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 September 2020, North Asia Strategic Holdings had an accrual ratio of -0.48. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$252m during the period, dwarfing its reported profit of HK$133.6m. North Asia Strategic Holdings did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

Our Take On North Asia Strategic Holdings' Profit Performance

Happily for shareholders, North Asia Strategic Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that North Asia Strategic Holdings' statutory profit actually understates its earnings potential! And the EPS is up 29% annually, over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of North Asia Strategic Holdings.

This note has only looked at a single factor that sheds light on the nature of North Asia Strategic Holdings' profit. 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. 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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