The market seemed underwhelmed by last week's earnings announcement from REF Holdings Limited (HKG:1631) despite the healthy numbers. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.
Check out our latest analysis for REF Holdings
A Closer Look At REF 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
REF Holdings has an accrual ratio of -1.22 for the year to December 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of HK$36m during the period, dwarfing its reported profit of HK$11.7m. REF Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of REF Holdings.
Our Take On REF Holdings' Profit Performance
As we discussed above, REF Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that REF Holdings' statutory profit actually understates its earnings potential! 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that REF Holdings is showing 2 warning signs in our investment analysis and 1 of those is a bit concerning...
This note has only looked at a single factor that sheds light on the nature of REF Holdings' profit. But there are plenty of other ways to inform your opinion of a company. 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. 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.
About SEHK:1631
REF Holdings
An investment holding company, provides financial printing services in Hong Kong.
Flawless balance sheet and fair value.