There May Be Underlying Issues With The Quality Of Huajin International Holdings' (HKG:2738) Earnings

Despite posting some strong earnings, the market for Huajin International Holdings Limited's (HKG:2738) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Huajin International Holdings

Zooming In On Huajin International Holdings' 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. 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. 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. 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, Huajin International Holdings had an accrual ratio of 0.42. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥895m, in contrast to the aforementioned profit of CN¥85.7m. We also note that Huajin International Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥895m.

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

Our Take On Huajin International Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Huajin International Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Huajin International Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. On the bright side, the company showed enough improvement to book a profit this year, after losing money 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. If you want to do dive deeper into Huajin International Holdings, you'd also look into what risks it is currently facing. For instance, we've identified 4 warning signs for Huajin International Holdings (3 shouldn't be ignored) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Huajin International Holdings' profit. 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 that insiders are buying to be useful.

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.