Weak Statutory Earnings May Not Tell The Whole Story For Sinohealth Holdings (HKG:2361)

A lackluster earnings announcement from Sinohealth Holdings Limited (HKG:2361) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Sinohealth Holdings

Zooming In On Sinohealth 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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 December 2022, Sinohealth Holdings recorded an accrual ratio of 0.47. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of CN¥28m during the period, falling well short of its reported profit of CN¥55.8m. Sinohealth Holdings' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

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.

Our Take On Sinohealth Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Sinohealth Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Sinohealth Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Sinohealth Holdings, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Sinohealth Holdings you should be mindful of and 1 of them is a bit unpleasant.

This note has only looked at a single factor that sheds light on the nature of Sinohealth Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.