Creative China Holdings' (HKG:8368) Shareholders May Want To Dig Deeper Than Statutory Profit

The recent earnings posted by Creative China Holdings Limited (HKG:8368) were solid, but the stock didn't move as much as we expected. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Creative China Holdings

Zooming In On Creative China 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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 2020, Creative China Holdings recorded an accrual ratio of 0.76. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥20.0m, a look at free cash flow indicates it actually burnt through CN¥24m in the last year. We also note that Creative China Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥24m.

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

Our Take On Creative China Holdings' Profit Performance

As we discussed above, we think Creative China Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Creative China Holdings' underlying earnings power is lower than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Case in point: We've spotted 3 warning signs for Creative China Holdings you should be mindful of and 1 of these can't be ignored.

This note has only looked at a single factor that sheds light on the nature of Creative China 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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