Minshang Creative Technology Holdings' (HKG:1632) Performance Is Even Better Than Its Earnings Suggest

Minshang Creative Technology Holdings Limited (HKG:1632) recently posted some strong earnings, and the market responded positively. Our analysis found some more factors that we think are good for shareholders.

Check out our latest analysis for Minshang Creative Technology Holdings

Zooming In On Minshang Creative Technology 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Minshang Creative Technology Holdings has an accrual ratio of -0.23 for the year to March 2021. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of HK$52m during the period, dwarfing its reported profit of HK$25.6m. Notably, Minshang Creative Technology Holdings had negative free cash flow last year, so the HK$52m it produced this year was a welcome improvement. 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 Minshang Creative Technology Holdings.

The Impact Of Unusual Items On Profit

Minshang Creative Technology Holdings' profit was reduced by unusual items worth HK$3.0m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Minshang Creative Technology Holdings took a rather significant hit from unusual items in the year to March 2021. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Minshang Creative Technology Holdings' Profit Performance

In conclusion, both Minshang Creative Technology Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Minshang Creative Technology Holdings' underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into Minshang Creative Technology Holdings, you'd also look into what risks it is currently facing. At Simply Wall St, we found 1 warning sign for Minshang Creative Technology Holdings and we think they deserve your attention.

Our examination of Minshang Creative Technology Holdings has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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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