We Think That There Are More Issues For Howkingtech International Holding (HKG:2440) Than Just Sluggish Earnings

Howkingtech International Holding Limited's (HKG:2440) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Howkingtech International Holding

Zooming In On Howkingtech International Holding's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Howkingtech International Holding has an accrual ratio of 0.35 for the year to December 2023. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of CN¥42m, in contrast to the aforementioned profit of CN¥25.5m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥42m, this year, indicates high risk.

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

Our Take On Howkingtech International Holding's Profit Performance

As we discussed above, we think Howkingtech International Holding's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Howkingtech International Holding's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. 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. Case in point: We've spotted 3 warning signs for Howkingtech International Holding you should be mindful of and 1 of these is a bit unpleasant.

Today we've zoomed in on a single data point to better understand the nature of Howkingtech International Holding's 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. 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.