We Believe Dynasty Fine Wines Group's (HKG:828) Earnings Are A Poor Guide For Its Profitability

After announcing healthy earnings, Dynasty Fine Wines Group Limited's (HKG:828) stock rose over the last week. Despite the strong profit numbers, we believe that there are some deeper issues which investors should look into.

We've found 21 US stocks that are forecast to pay a dividend yield of over 6% next year. See the full list for free.

Zooming In On Dynasty Fine Wines Group's 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. 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. 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. 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, Dynasty Fine Wines Group had an accrual ratio of 0.44. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of HK$41m, in contrast to the aforementioned profit of HK$33.4m. We also note that Dynasty Fine Wines Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$41m. 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.

Check out our latest analysis for Dynasty Fine Wines Group

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dynasty Fine Wines Group.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Dynasty Fine Wines Group's profit was boosted by unusual items worth HK$11m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. We can see that Dynasty Fine Wines Group's positive unusual items were quite significant relative to its profit in the year to December 2024. 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 Dynasty Fine Wines Group's Profit Performance

Summing up, Dynasty Fine Wines Group received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. On reflection, the above-mentioned factors give us the strong impression that Dynasty Fine Wines Group'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 2 warning signs for Dynasty Fine Wines Group (of which 1 is concerning!) you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.