Earnings Troubles May Signal Larger Issues for Perennial Energy Holdings (HKG:2798) Shareholders

A lackluster earnings announcement from Perennial Energy Holdings Limited (HKG:2798) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Perennial Energy Holdings

Zooming In On Perennial Energy Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Perennial Energy Holdings has an accrual ratio of 0.31 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Even though it reported a profit of CN¥504.2m, a look at free cash flow indicates it actually burnt through CN¥516m in the last year. We also note that Perennial Energy Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥516m.

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

Our Take On Perennial Energy Holdings' Profit Performance

Perennial Energy Holdings didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Perennial Energy Holdings' statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 46% per annum growth in EPS for the last three. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. When we did our research, we found 2 warning signs for Perennial Energy Holdings (1 makes us a bit uncomfortable!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Perennial Energy 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. 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. 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.