Solid Earnings May Not Tell The Whole Story For New Hope Service Holdings (HKG:3658)

The market shrugged off New Hope Service Holdings Limited's (HKG:3658) solid earnings report. We think that investors might be worried about some concerning underlying factors.

View our latest analysis for New Hope Service Holdings

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

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

New Hope Service Holdings has an accrual ratio of 0.38 for the year to June 2023. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of CN¥176m in the last year, which was a lot less than its statutory profit of CN¥212.6m. At this point we should mention that New Hope Service Holdings did manage to increase its free cash flow in the last twelve months

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 New Hope Service Holdings' Profit Performance

As we discussed above, we think New Hope Service Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that New Hope Service Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. And we are pleased to note that EPS is at least heading in the right direction in the alst twelve months. 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. So while earnings quality is important, it's equally important to consider the risks facing New Hope Service Holdings at this point in time. Be aware that New Hope Service Holdings is showing 2 warning signs in our investment analysis and 1 of those is significant...

Today we've zoomed in on a single data point to better understand the nature of New Hope Service Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.