We Don’t Think Howkingtech International Holding's (HKG:2440) Earnings Should Make Shareholders Too Comfortable

Howkingtech International Holding Limited (HKG:2440) posted some decent earnings, but shareholders didn't react strongly. Our analysis has found some concerning factors which weaken the profit's foundation.

Check out our latest analysis for Howkingtech International Holding

Examining Cashflow Against Howkingtech International Holding's 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Howkingtech International Holding has an accrual ratio of 0.44 for the year to June 2023. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥32.8m, a look at free cash flow indicates it actually burnt through CN¥36m in the last year. We saw that FCF was CN¥7.3m a year ago though, so Howkingtech International Holding has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Howkingtech International Holding.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Howkingtech International Holding's profit was boosted by unusual items worth CN¥2.4m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Howkingtech International Holding doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Howkingtech International Holding's Profit Performance

Summing up, Howkingtech International Holding received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Howkingtech International Holding's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 4 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Howkingtech International Holding.

Our examination of Howkingtech International Holding has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.