Redsun Services Group's (HKG:1971) Anemic Earnings Might Be Worse Than You Think

Despite Redsun Services Group Limited's (HKG:1971) recent earnings report having lackluster headline numbers, the market responded positively. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Redsun Services Group.

View our latest analysis for Redsun Services Group

Examining Cashflow Against Redsun Services Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2022, Redsun Services Group had an accrual ratio of 1.13. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥201m, in contrast to the aforementioned profit of CN¥92.0m. It's worth noting that Redsun Services Group generated positive FCF of CN¥186m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Redsun Services Group.

Our Take On Redsun Services Group's Profit Performance

As we have made quite clear, we're a bit worried that Redsun Services Group didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Redsun Services Group's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 13% per annum growth in EPS for the last three. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example - Redsun Services Group has 1 warning sign we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Redsun Services 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.