There Are Some Reasons To Suggest That Scholar Education Group's (HKG:1769) Earnings Are A Poor Reflection Of Profitability

Shareholders didn't seem to be thrilled with Scholar Education Group's (HKG:1769) recent earnings report, despite healthy profit numbers. We think that they might be concerned about some underlying details that our analysis found.

View our latest analysis for Scholar Education Group

Zooming In On Scholar Education Group'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. 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 2023, Scholar Education Group had an accrual ratio of 0.45. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of CN¥95m in the last year, which was a lot less than its statutory profit of CN¥129.4m. We note, however, that Scholar Education Group grew its free cash flow over the last year. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Scholar Education Group's profit was boosted by unusual items worth CN¥92m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. We can see that Scholar Education Group's positive unusual items were quite significant relative to its profit in the year to June 2023. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Scholar Education Group's Profit Performance

Summing up, Scholar Education Group received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For all the reasons mentioned above, we think that, at a glance, Scholar Education Group's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you'd like to know more about Scholar Education Group as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Scholar Education Group (2 are potentially serious!) that we believe deserve your full attention.

Our examination of Scholar Education Group 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 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.

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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.