Star Plus Legend Holdings' (HKG:6683) Promising Earnings May Rest On Soft Foundations

Despite posting some strong earnings, the market for Star Plus Legend Holdings Limited's (HKG:6683) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

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Examining Cashflow Against Star Plus Legend Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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.

For the year to December 2024, Star Plus Legend Holdings had an accrual ratio of 0.20. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥58m, in contrast to the aforementioned profit of CN¥56.1m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥58m, this year, indicates high risk. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

View our latest analysis for Star Plus Legend Holdings

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Star Plus Legend Holdings.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥16m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Star Plus Legend Holdings doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Star Plus Legend Holdings' Profit Performance

Star Plus Legend Holdings had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Star Plus Legend Holdings' statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Star Plus Legend Holdings, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 1 warning sign for Star Plus Legend Holdings you should know about.

Our examination of Star Plus Legend Holdings has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. 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 with significant insider holdings 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.