Some May Be Optimistic About Hang Chi Holdings' (HKG:8405) Earnings

The most recent earnings report from Hang Chi Holdings Limited (HKG:8405) was disappointing for shareholders. However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

See our latest analysis for Hang Chi Holdings

Zooming In On Hang Chi Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2023, Hang Chi Holdings had an accrual ratio of -0.35. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of HK$69m, well over the HK$23.4m it reported in profit. Hang Chi Holdings' 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 Hang Chi Holdings.

Our Take On Hang Chi Holdings' Profit Performance

As we discussed above, Hang Chi Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Hang Chi Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the 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 Hang Chi Holdings at this point in time. While conducting our analysis, we found that Hang Chi Holdings has 3 warning signs and it would be unwise to ignore them.

This note has only looked at a single factor that sheds light on the nature of Hang Chi Holdings' 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. 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.