We Think E-Commodities Holdings's (HKG:1733) Statutory Profit Might Understate Its Earnings Potential

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing E-Commodities Holdings (HKG:1733).

It's good to see that over the last twelve months E-Commodities Holdings made a profit of HK$329.7m on revenue of HK$29.2b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

View our latest analysis for E-Commodities 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. Today, we'll discuss E-Commodities Holdings' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of E-Commodities Holdings.

Zooming In On E-Commodities 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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 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.

For the year to June 2020, E-Commodities Holdings had an accrual ratio of -0.53. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$2.4b in the last year, which was a lot more than its statutory profit of HK$329.7m. E-Commodities Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On E-Commodities Holdings' Profit Performance

Happily for shareholders, E-Commodities Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think E-Commodities 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. 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 while earnings quality is important, it's equally important to consider the risks facing E-Commodities Holdings at this point in time. You'd be interested to know, that we found 3 warning signs for E-Commodities Holdings and you'll want to know about them.

Today we've zoomed in on a single data point to better understand the nature of E-Commodities 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. 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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