There May Be Reason For Hope In Health and Happiness (H&H) International Holdings' (HKG:1112) Disappointing Earnings

Health and Happiness (H&H) International Holdings Limited's (HKG:1112) recent soft profit numbers didn't appear to worry shareholders. We think that investors might be looking at some positive factors beyond the earnings numbers.

View our latest analysis for Health and Happiness (H&H) International Holdings

Zooming In On Health and Happiness (H&H) International Holdings' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Health and Happiness (H&H) International Holdings has an accrual ratio of -0.11 for the year to December 2021. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of CN¥1.8b during the period, dwarfing its reported profit of CN¥508.5m. Health and Happiness (H&H) International Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

Health and Happiness (H&H) International Holdings' profit was reduced by unusual items worth CN¥134m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. 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. Assuming those unusual expenses don't come up again, we'd therefore expect Health and Happiness (H&H) International Holdings to produce a higher profit next year, all else being equal.

Our Take On Health and Happiness (H&H) International Holdings' Profit Performance

In conclusion, both Health and Happiness (H&H) International Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that Health and Happiness (H&H) International Holdings' underlying earnings power is at least as good as the statutory numbers would make it seem. If you'd like to know more about Health and Happiness (H&H) International Holdings as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 4 warning signs (1 is a bit unpleasant!) that you ought to be aware of before buying any shares in Health and Happiness (H&H) International Holdings.

After our examination into the nature of Health and Happiness (H&H) International Holdings' profit, we've come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying 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.