We Think That There Are Issues Underlying Guangdong - Hong Kong Greater Bay Area Holdings' (HKG:1396) Earnings

Despite posting some strong earnings, the market for Guangdong - Hong Kong Greater Bay Area Holdings Limited's (HKG:1396) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

View our latest analysis for Guangdong - Hong Kong Greater Bay Area Holdings

A Closer Look At Guangdong - Hong Kong Greater Bay Area 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 June 2021, Guangdong - Hong Kong Greater Bay Area Holdings had an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥1.8b, in contrast to the aforementioned profit of CN¥335.9m. We saw that FCF was CN¥12m a year ago though, so Guangdong - Hong Kong Greater Bay Area Holdings has at least been able to generate positive FCF in the past. One positive for Guangdong - Hong Kong Greater Bay Area Holdings shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangdong - Hong Kong Greater Bay Area Holdings.

Our Take On Guangdong - Hong Kong Greater Bay Area Holdings' Profit Performance

Guangdong - Hong Kong Greater Bay Area Holdings' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Guangdong - Hong Kong Greater Bay Area Holdings' true underlying earnings power is actually less than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Guangdong - Hong Kong Greater Bay Area Holdings.

This note has only looked at a single factor that sheds light on the nature of Guangdong - Hong Kong Greater Bay Area Holdings' 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.
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