Here's Why We Think MS Group Holdings's (HKG:1451) Statutory Earnings Might Be Conservative

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding MS Group Holdings (HKG:1451).

We like the fact that MS Group Holdings made a profit of HK$14.2m on its revenue of HK$235.9m, in the last year. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

View our latest analysis for MS Group Holdings

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what MS Group Holdings' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of MS Group Holdings.

A Closer Look At MS Group 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. 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 2020, MS Group Holdings had an accrual ratio of -0.26. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of HK$31m in the last year, which was a lot more than its statutory profit of HK$14.2m. MS Group Holdings' free cash flow improved over the last year, which is generally good to see.

Our Take On MS Group Holdings' Profit Performance

Happily for shareholders, MS Group Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that MS Group Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 2 warning signs for MS Group Holdings (of which 1 is concerning!) you should know about.

This note has only looked at a single factor that sheds light on the nature of MS Group Holdings' profit. 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.

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This article by Simply Wall St is general in nature. 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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