We Think Shareholders Should Be Aware Of Some Factors Beyond China Health Technology Group Holding's (HKG:1069) Profit

Despite posting strong earnings, China Health Technology Group Holding Company Limited's (HKG:1069) stock didn't move much over the last week. We think that investors might be worried about the foundations the earnings are built on.

Check out our latest analysis for China Health Technology Group Holding

Zooming In On China Health Technology Group Holding's 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to December 2023, China Health Technology Group Holding had an accrual ratio of 3.27. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥21m despite its profit of CN¥191.9m, mentioned above. It's worth noting that China Health Technology Group Holding generated positive FCF of CN¥25m a year ago, so at least they've done it in the past. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. One positive for China Health Technology Group Holding shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Health Technology Group Holding.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. China Health Technology Group Holding expanded the number of shares on issue by 550% over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out China Health Technology Group Holding's historical EPS growth by clicking on this link.

How Is Dilution Impacting China Health Technology Group Holding's Earnings Per Share (EPS)?

Three years ago, China Health Technology Group Holding lost money. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If China Health Technology Group Holding's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that China Health Technology Group Holding's profit was boosted by unusual items worth CN¥244m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. China Health Technology Group Holding had a rather significant contribution from unusual items relative to its profit to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On China Health Technology Group Holding's Profit Performance

China Health Technology Group Holding didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. The dilution means the results are weaker when viewed from a per-share perspective. On reflection, the above-mentioned factors give us the strong impression that China Health Technology Group Holding'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've discovered 4 warning signs that you should run your eye over to get a better picture of China Health Technology Group Holding.

Our examination of China Health Technology Group Holding has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.