Are Cabbeen Fashion's (HKG:2030) Statutory Earnings A Good Guide To Its Underlying Profitability?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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 Cabbeen Fashion's (HKG:2030) statutory profits are a good guide to its underlying earnings.

While Cabbeen Fashion was able to generate revenue of CN¥1.81b in the last twelve months, we think its profit result of CN¥194.2m was more important. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

See our latest analysis for Cabbeen Fashion

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. As a result, we think it's well worth considering what Cabbeen Fashion's 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 Cabbeen Fashion.

Zooming In On Cabbeen Fashion's 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

For the year to December 2020, Cabbeen Fashion had an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥352m during the period, dwarfing its reported profit of CN¥194.2m. Given that Cabbeen Fashion had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥352m would seem to be a step in the right direction.

Our Take On Cabbeen Fashion's Profit Performance

Happily for shareholders, Cabbeen Fashion produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Cabbeen Fashion's statutory profit actually understates its earnings potential! And the EPS is up 23% over the last twelve months. 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. If you want to do dive deeper into Cabbeen Fashion, you'd also look into what risks it is currently facing. Our analysis shows 2 warning signs for Cabbeen Fashion (1 is concerning!) and we strongly recommend you look at these bad boys before investing.

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

If you decide to trade Cabbeen Fashion, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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