Should You Rely On Town Ray Holdings's (HKG:1692) Earnings Growth?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. This article will consider whether Town Ray Holdings' (HKG:1692) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Town Ray Holdings made a profit of HK$70.7m on revenue of HK$491.3m. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for Town Ray 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 Town Ray 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 Town Ray Holdings.

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

For the year to June 2020, Town Ray Holdings had an accrual ratio of -0.67. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$143m during the period, dwarfing its reported profit of HK$70.7m. Town Ray Holdings' free cash flow improved over the last year, which is generally good to see.

Our Take On Town Ray Holdings' Profit Performance

As we discussed above, Town Ray Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Town Ray Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 21% 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. You'd be interested to know, that we found 2 warning signs for Town Ray Holdings and you'll want to know about them.

Today we've zoomed in on a single data point to better understand the nature of Town Ray 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. 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. 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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