We Wouldn't Rely On Snack Empire Holdings's (HKG:1843) Statutory Earnings As A Guide

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Snack Empire Holdings (HKG:1843).

While Snack Empire Holdings was able to generate revenue of S$23.0m in the last twelve months, we think its profit result of S$2.83m was more important. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

See our latest analysis for Snack Empire Holdings

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Snack Empire Holdings' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Snack Empire Holdings.

Zooming In On Snack Empire Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2020, Snack Empire Holdings recorded an accrual ratio of 1.01. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of S$2.83m, a look at free cash flow indicates it actually burnt through S$710k in the last year. It's worth noting that Snack Empire Holdings generated positive FCF of S$3.6m a year ago, so at least they've done it in the past.

Our Take On Snack Empire Holdings' Profit Performance

As we discussed above, we think Snack Empire Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Snack Empire Holdings' underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've found that Snack Empire Holdings has 2 warning signs (1 is potentially serious!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Snack Empire Holdings' 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. 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 that insiders are buying to be useful.

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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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