Stock Analysis

Should You Use SinoMedia Holding's (HKG:623) Statutory Earnings To Analyse It?

SEHK:623
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Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding SinoMedia Holding (HKG:623).

It's good to see that over the last twelve months SinoMedia Holding made a profit of CN¥135.6m on revenue of CN¥1.38b.

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earnings-and-revenue-history
SEHK:623 Earnings and Revenue History December 15th 2020

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. As a result, today we're going to take a closer look at SinoMedia Holding's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of SinoMedia Holding.

Examining Cashflow Against SinoMedia Holding's 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

SinoMedia Holding has an accrual ratio of -0.15 for the year to June 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥260m in the last year, which was a lot more than its statutory profit of CN¥135.6m. SinoMedia Holding shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

Surprisingly, given SinoMedia Holding's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥83m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that SinoMedia Holding's positive unusual items were quite significant relative to its profit in the year to June 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On SinoMedia Holding's Profit Performance

SinoMedia Holding's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, we think it's very unlikely that SinoMedia Holding's statutory profits make it seem much weaker than it is. If you'd like to know more about SinoMedia Holding as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 4 warning signs for SinoMedia Holding (of which 1 is a bit concerning!) you should know about.

Our examination of SinoMedia Holding has focussed on certain factors that can make its earnings look better than they are. 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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