Earnings Troubles May Signal Larger Issues for Chen Lin Education Group Holdings (HKG:1593) Shareholders

The subdued market reaction suggests that Chen Lin Education Group Holdings Limited's (HKG:1593) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Chen Lin Education Group Holdings

Examining Cashflow Against Chen Lin Education Group Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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".

Over the twelve months to August 2024, Chen Lin Education Group Holdings recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥406m, in contrast to the aforementioned profit of CN¥15.4m. We also note that Chen Lin Education Group Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥406m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chen Lin Education Group Holdings.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Chen Lin Education Group Holdings' profit was boosted by unusual items worth CN¥22m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Chen Lin Education Group Holdings' Profit Performance

Chen Lin Education Group Holdings had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Chen Lin Education Group Holdings' statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Chen Lin Education Group Holdings has 4 warning signs (3 are significant!) that deserve your attention before going any further with your analysis.

Our examination of Chen Lin Education Group Holdings has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. 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 with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.