Here's Why We Think Shaw Brothers Holdings's (HKG:953) Statutory Earnings Might Be Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. 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. This article will consider whether Shaw Brothers Holdings' (HKG:953) statutory profits are a good guide to its underlying earnings.

We like the fact that Shaw Brothers Holdings made a profit of CN¥7.69m on its revenue of CN¥290.0m, in the last year. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.

View our latest analysis for Shaw Brothers Holdings

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Shaw Brothers Holdings' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shaw Brothers Holdings.

A Closer Look At Shaw Brothers 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Shaw Brothers Holdings has an accrual ratio of -0.73 for the year to June 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥90m in the last year, which was a lot more than its statutory profit of CN¥7.69m. Given that Shaw Brothers Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥90m would seem to be a step in the right direction.

Our Take On Shaw Brothers Holdings' Profit Performance

As we discussed above, Shaw Brothers Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Shaw Brothers Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 2 warning signs with Shaw Brothers Holdings, and understanding them should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Shaw Brothers 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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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