We Think Bamboos Health Care Holdings's (HKG:2293) Statutory Profit Might Understate Its 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 Bamboos Health Care Holdings (HKG:2293).

It's good to see that over the last twelve months Bamboos Health Care Holdings made a profit of HK$30.7m on revenue of HK$76.4m. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

View our latest analysis for Bamboos Health Care Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Bamboos Health Care Holdings' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Bamboos Health Care Holdings.

Zooming In On Bamboos Health Care Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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 2020, Bamboos Health Care Holdings had an accrual ratio of -0.30. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$42m in the last year, which was a lot more than its statutory profit of HK$30.7m. Bamboos Health Care Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Bamboos Health Care Holdings' Profit Performance

Happily for shareholders, Bamboos Health Care Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Bamboos Health Care Holdings' statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. You'd be interested to know, that we found 2 warning signs for Bamboos Health Care Holdings and you'll want to know about them.

This note has only looked at a single factor that sheds light on the nature of Bamboos Health Care Holdings' profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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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