Is There More To The Story Than Justin Allen Holdings's (HKG:1425) Earnings Growth?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Justin Allen Holdings' (HKG:1425) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Justin Allen Holdings made a profit of HK$70.7m on revenue of HK$688.6m. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Justin Allen Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Justin Allen Holdings' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Justin Allen Holdings.

A Closer Look At Justin Allen 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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Justin Allen Holdings has an accrual ratio of -0.23 for the year to June 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of HK$135m, well over the HK$70.7m it reported in profit. Justin Allen Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Justin Allen Holdings' Profit Performance

Happily for shareholders, Justin Allen Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Justin Allen Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 20% per year over the last three years. 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 2 warning signs for Justin Allen Holdings you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Justin Allen Holdings' 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. 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. 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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