Robust Earnings May Not Tell The Whole Story For China Finance Investment Holdings (HKG:875)

Unsurprisingly, China Finance Investment Holdings Limited's (HKG:875) stock price was strong on the back of its healthy earnings report. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for China Finance Investment Holdings

A Closer Look At China Finance Investment 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. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

For the year to June 2022, China Finance Investment Holdings had an accrual ratio of 0.44. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of HK$38.1m, a look at free cash flow indicates it actually burnt through HK$257m in the last year. We also note that China Finance Investment Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$257m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Finance Investment Holdings.

Our Take On China Finance Investment Holdings' Profit Performance

As we discussed above, we think China Finance Investment Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that China Finance Investment Holdings' underlying earnings power is lower than its statutory profit. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 4 warning signs for China Finance Investment Holdings (3 are concerning!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of China Finance Investment Holdings' profit. 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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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.