KOS International Holdings (HKG:8042) Posted Healthy Earnings But There Are Some Other Factors To Be Aware Of

KOS International Holdings Limited (HKG:8042) just reported some strong earnings, and the market rewarded them with a positive share price move. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Check out our latest analysis for KOS International Holdings

A Closer Look At KOS International 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2021, KOS International Holdings recorded an accrual ratio of 0.20. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of HK$11m in the last year, which was a lot less than its statutory profit of HK$12.8m. We note, however, that KOS International Holdings grew its free cash flow over the last year. The good news for shareholders is that KOS International Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On KOS International Holdings' Profit Performance

KOS International Holdings' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that KOS International Holdings' true underlying earnings power is actually less than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. 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. Every company has risks, and we've spotted 4 warning signs for KOS International Holdings (of which 3 are a bit unpleasant!) you should know about.

This note has only looked at a single factor that sheds light on the nature of KOS International 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.