Investors Can Find Comfort In UMP Healthcare Holdings' (HKG:722) Earnings Quality

The market for UMP Healthcare Holdings Limited's (HKG:722) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for UMP Healthcare Holdings

A Closer Look At UMP Healthcare 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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 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.

UMP Healthcare Holdings has an accrual ratio of -0.30 for the year to June 2021. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$147m in the last year, which was a lot more than its statutory profit of HK$34.8m. UMP Healthcare Holdings' free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

How Do Unusual Items Influence Profit?

UMP Healthcare Holdings' profit was reduced by unusual items worth HK$22m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect UMP Healthcare Holdings to produce a higher profit next year, all else being equal.

Our Take On UMP Healthcare Holdings' Profit Performance

In conclusion, both UMP Healthcare Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think UMP Healthcare Holdings' underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into UMP Healthcare Holdings, you'd also look into what risks it is currently facing. For example, we've discovered 4 warning signs that you should run your eye over to get a better picture of UMP Healthcare Holdings.

After our examination into the nature of UMP Healthcare Holdings' profit, we've come away optimistic for the company. 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. 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.

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.

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