Stock Analysis

Is There More To The Story Than Hung Fook Tong Group Holdings's (HKG:1446) Earnings Growth?

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Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Hung Fook Tong Group Holdings' (HKG:1446) statutory profits are a good guide to its underlying earnings.

While Hung Fook Tong Group Holdings was able to generate revenue of HK$730.1m in the last twelve months, we think its profit result of HK$28.0m was more important. As you can see in the chart below, it has grown its profits over the last three years, despite the fact its revenue has been steady.

See our latest analysis for Hung Fook Tong Group Holdings

SEHK:1446 Earnings and Revenue History December 25th 2020

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, today we're going to take a closer look at Hung Fook Tong Group Holdings' cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hung Fook Tong Group Holdings.

Examining Cashflow Against Hung Fook Tong Group 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Hung Fook Tong Group Holdings has an accrual ratio of -0.40 for the year to June 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of HK$134m, well over the HK$28.0m it reported in profit. Given that Hung Fook Tong Group Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$134m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Hung Fook Tong Group Holdings' profit was boosted by unusual items worth HK$9.8m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Hung Fook Tong Group Holdings had a rather significant contribution from unusual items relative to its profit to June 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Hung Fook Tong Group Holdings' Profit Performance

In conclusion, Hung Fook Tong Group Holdings' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. After taking into account all these factors, we think that Hung Fook Tong Group Holdings' statutory results are a decent reflection of its underlying earnings power. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Hung Fook Tong Group Holdings.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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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