S-Enjoy Service Group's (HKG:1755) Profits Appear To Have Quality Issues

The stock price didn't jump after S-Enjoy Service Group Co., Limited (HKG:1755) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.

See our latest analysis for S-Enjoy Service Group

Zooming In On S-Enjoy Service Group'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. The ratio shows us how much a company's profit exceeds its FCF.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2023, S-Enjoy Service Group had an accrual ratio of 0.45. 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. To wit, it produced free cash flow of CN¥383m during the period, falling well short of its reported profit of CN¥491.4m. We note, however, that S-Enjoy Service Group grew its free cash flow over the last year.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On S-Enjoy Service Group's Profit Performance

As we discussed above, we think S-Enjoy Service Group's 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 S-Enjoy Service Group's underlying earnings power is lower than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 33% over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing S-Enjoy Service Group at this point in time. Be aware that S-Enjoy Service Group is showing 3 warning signs in our investment analysis and 1 of those is potentially serious...

Today we've zoomed in on a single data point to better understand the nature of S-Enjoy Service Group'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. 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. 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.