Investors Can Find Comfort In Weiqiao Textile's (HKG:2698) Earnings Quality

Soft earnings didn't appear to concern Weiqiao Textile Company Limited's (HKG:2698) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

Check out our latest analysis for Weiqiao Textile

Examining Cashflow Against Weiqiao Textile's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2020, Weiqiao Textile had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥1.4b, well over the CN¥204.8m it reported in profit. Weiqiao Textile's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Weiqiao Textile.

Our Take On Weiqiao Textile's Profit Performance

As we discussed above, Weiqiao Textile has perfectly satisfactory free cash flow relative to profit. Because of this, we think Weiqiao Textile's earnings potential is at least as good as it seems, and maybe even better! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you want to do dive deeper into Weiqiao Textile, you'd also look into what risks it is currently facing. For instance, we've identified 2 warning signs for Weiqiao Textile (1 can't be ignored) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Weiqiao Textile's 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. 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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