Loco Hong Kong Holdings' (HKG:8162) Earnings Are Weaker Than They Seem

Despite posting some strong earnings, the market for Loco Hong Kong Holdings Limited's (HKG:8162) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

See our latest analysis for Loco Hong Kong Holdings

Examining Cashflow Against Loco Hong Kong 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 June 2024, Loco Hong Kong Holdings had an accrual ratio of 0.48. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of HK$801k in the last year, which was a lot less than its statutory profit of HK$22.7m. Given that Loco Hong Kong Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$801k would seem to be a step in the right direction.

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

Our Take On Loco Hong Kong Holdings' Profit Performance

As we discussed above, we think Loco Hong Kong Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Loco Hong Kong Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. 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. To help with this, we've discovered 3 warning signs (2 make us uncomfortable!) that you ought to be aware of before buying any shares in Loco Hong Kong Holdings.

Today we've zoomed in on a single data point to better understand the nature of Loco Hong Kong 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 with high insider ownership.

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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.