Here's Why We Don't Think COFCO Joycome Foods' (HKG:1610) Statutory Earnings Reflect Its Underlying Earnings Potential

As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding COFCO Joycome Foods (HKG:1610).

We like the fact that COFCO Joycome Foods made a profit of CN¥3.49b on its revenue of CN¥15.8b, in the last year.

View our latest analysis for COFCO Joycome Foods

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 COFCO Joycome Foods' cashflow tells us about the quality of its earnings. 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.

Zooming In On COFCO Joycome Foods' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to June 2020, COFCO Joycome Foods recorded an accrual ratio of 0.46. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥3.3b, in contrast to the aforementioned profit of CN¥3.49b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥3.3b, this year, indicates high risk.

Our Take On COFCO Joycome Foods' Profit Performance

As we have made quite clear, we're a bit worried that COFCO Joycome Foods didn't back up the last year's profit with free cashflow. For this reason, we think that COFCO Joycome Foods' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 5 warning signs for COFCO Joycome Foods (3 don't sit too well with us) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of COFCO Joycome Foods' 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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