We're Not Counting On Jiu Zun Digital Interactive Entertainment Group Holdings (HKG:1961) To Sustain Its Statutory Profitability

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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 Jiu Zun Digital Interactive Entertainment Group Holdings (HKG:1961).

While Jiu Zun Digital Interactive Entertainment Group Holdings was able to generate revenue of CN¥205.9m in the last twelve months, we think its profit result of CN¥25.7m was more important. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

Check out our latest analysis for Jiu Zun Digital Interactive Entertainment Group Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss Jiu Zun Digital Interactive Entertainment Group 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 Jiu Zun Digital Interactive Entertainment Group Holdings.

Examining Cashflow Against Jiu Zun Digital Interactive Entertainment Group 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. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Jiu Zun Digital Interactive Entertainment Group Holdings has an accrual ratio of 0.82 for the year to June 2020. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥52m despite its profit of CN¥25.7m, mentioned above. We also note that Jiu Zun Digital Interactive Entertainment Group Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥52m.

Our Take On Jiu Zun Digital Interactive Entertainment Group Holdings' Profit Performance

As we discussed above, we think Jiu Zun Digital Interactive Entertainment Group Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Jiu Zun Digital Interactive Entertainment Group Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. 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. So while earnings quality is important, it's equally important to consider the risks facing Jiu Zun Digital Interactive Entertainment Group Holdings at this point in time. Every company has risks, and we've spotted 6 warning signs for Jiu Zun Digital Interactive Entertainment Group Holdings (of which 2 are significant!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Jiu Zun Digital Interactive Entertainment Group Holdings' profit. But there are plenty of other ways to inform your opinion of a company. 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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