Shareholders Will Be Pleased With The Quality of Mega Genomics' (HKG:6667) Earnings

The subdued stock price reaction suggests that Mega Genomics Limited's (HKG:6667) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Check out our latest analysis for Mega Genomics

Zooming In On Mega Genomics' 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. 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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 2024, Mega Genomics had an accrual ratio of -0.28. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥87m during the period, dwarfing its reported profit of CN¥31.9m. Mega Genomics' free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mega Genomics.

Our Take On Mega Genomics' Profit Performance

Happily for shareholders, Mega Genomics produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Mega Genomics' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Mega Genomics at this point in time. Case in point: We've spotted 1 warning sign for Mega Genomics you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Mega Genomics' profit. 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.

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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.