Icon Culture Global Company Limited's (HKG:8500) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.
A Closer Look At Icon Culture Global's 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.
Icon Culture Global has an accrual ratio of 0.67 for the year to June 2021. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of CN¥2.5m in the last year, which was a lot less than its statutory profit of CN¥36.9m. Notably, Icon Culture Global had negative free cash flow last year, so the CN¥2.5m it produced this year was a welcome improvement.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Icon Culture Global.
Our Take On Icon Culture Global's Profit Performance
As we have made quite clear, we're a bit worried that Icon Culture Global didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Icon Culture Global's underlying earnings power is lower than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. If you'd like to know more about Icon Culture Global as a business, it's important to be aware of any risks it's facing. For example, Icon Culture Global has 2 warning signs (and 1 which is a bit concerning) we think you should know about.
Today we've zoomed in on a single data point to better understand the nature of Icon Culture Global's 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. 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.
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