China General Education Group's (HKG:2175) Soft Earnings Don't Show The Whole Picture

Shareholders appeared unconcerned with China General Education Group Limited's (HKG:2175) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for China General Education Group

Examining Cashflow Against China General Education Group'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. 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

China General Education Group has an accrual ratio of -0.21 for the year to August 2021. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥255m in the last year, which was a lot more than its statutory profit of CN¥129.8m. Given that China General Education Group had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥255m would seem to be a step in the right direction.

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

Our Take On China General Education Group's Profit Performance

As we discussed above, China General Education Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that China General Education Group's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. We've done some analysis and you can see our take on China General Education Group's balance sheet by clicking here.

Today we've zoomed in on a single data point to better understand the nature of China General Education Group's profit. 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. 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.