Is There More To The Story Than Ye Xing Group Holdings's (HKG:1941) Earnings Growth?

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 Ye Xing Group Holdings' (HKG:1941) statutory profits are a good guide to its underlying earnings.

We like the fact that Ye Xing Group Holdings made a profit of CN¥43.0m on its revenue of CN¥282.4m, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Ye Xing Group Holdings

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Ye Xing Group 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 Ye Xing Group Holdings.

Examining Cashflow Against Ye Xing Group 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.

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. 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.

Over the twelve months to June 2020, Ye Xing Group Holdings recorded an accrual ratio of 1.62. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥43.0m, a look at free cash flow indicates it actually burnt through CN¥51m in the last year. We saw that FCF was CN¥28m a year ago though, so Ye Xing Group Holdings has at least been able to generate positive FCF in the past.

Our Take On Ye Xing Group Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Ye Xing Group Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Ye Xing Group Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 15% per annum growth in EPS for the last three. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Ye Xing Group Holdings at this point in time. Be aware that Ye Xing Group Holdings is showing 4 warning signs in our investment analysis and 1 of those is significant...

Today we've zoomed in on a single data point to better understand the nature of Ye Xing Group 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 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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