We Wouldn't Rely On SG Group Holdings's (HKG:1657) Statutory Earnings As A Guide

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding SG Group Holdings (HKG:1657).

While SG Group Holdings was able to generate revenue of HK$257.3m in the last twelve months, we think its profit result of HK$15.8m was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).

View our latest analysis for SG 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 SG 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 SG Group Holdings.

Zooming In On SG Group Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

SG Group Holdings has an accrual ratio of 0.37 for the year to April 2020. 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. Over the last year it actually had negative free cash flow of HK$12m, in contrast to the aforementioned profit of HK$15.8m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$12m, this year, indicates high risk.

Our Take On SG Group Holdings' Profit Performance

As we have made quite clear, we're a bit worried that SG Group Holdings didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that SG Group Holdings' underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. 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 SG Group Holdings.

This note has only looked at a single factor that sheds light on the nature of SG Group Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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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