Jia Yao Holdings' (HKG:1626) Weak Earnings May Only Reveal A Part Of The Whole Picture

Last week's earnings announcement from Jia Yao Holdings Limited (HKG:1626) was disappointing to investors, with a sluggish profit figure. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

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Examining Cashflow Against Jia Yao Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2024, Jia Yao Holdings recorded an accrual ratio of 0.32. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of CN¥21.2m, a look at free cash flow indicates it actually burnt through CN¥48m in the last year. We saw that FCF was CN¥32m a year ago though, so Jia Yao Holdings has at least been able to generate positive FCF in the past. 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.

Check out our latest analysis for Jia Yao Holdings

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Jia Yao Holdings' profit was boosted by unusual items worth CN¥3.7m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Jia Yao Holdings doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Jia Yao Holdings' Profit Performance

Summing up, Jia Yao Holdings received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Jia Yao Holdings' statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Jia Yao Holdings at this point in time. Every company has risks, and we've spotted 3 warning signs for Jia Yao Holdings (of which 1 is potentially serious!) you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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 with significant insider holdings 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.