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. However, we believe that investors should be aware of some underlying factors which may be of concern.

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Zooming In On Perennial Energy 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2024, Perennial Energy Holdings recorded an accrual ratio of 0.32. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of CN¥789m, in contrast to the aforementioned profit of CN¥440.2m. 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¥789m.

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' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Perennial Energy Holdings' true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 46% per annum growth in EPS for the last three. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Perennial Energy Holdings.

This note has only looked at a single factor that sheds light on the nature of Perennial Energy 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 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.