We Wouldn't Rely On Sansheng Holdings (Group)'s (HKG:2183) Statutory Earnings As A Guide

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Sansheng Holdings (Group)'s (HKG:2183) statutory profits are a good guide to its underlying earnings.

While Sansheng Holdings (Group) was able to generate revenue of CN¥3.58b in the last twelve months, we think its profit result of CN¥294.6m was more important. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

View our latest analysis for Sansheng Holdings (Group)

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Sansheng Holdings (Group)'s cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sansheng Holdings (Group).

Examining Cashflow Against Sansheng Holdings (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.

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. 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 2020, Sansheng Holdings (Group) had an accrual ratio of 0.26. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥294.6m, a look at free cash flow indicates it actually burnt through CN¥2.2b in the last year. We also note that Sansheng Holdings (Group)'s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥2.2b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Sansheng Holdings (Group) increased the number of shares on issue by 11% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Sansheng Holdings (Group)'s EPS by clicking here.

How Is Dilution Impacting Sansheng Holdings (Group)'s Earnings Per Share? (EPS)

Three years ago, Sansheng Holdings (Group) lost money. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Sansheng Holdings (Group)'s EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Sansheng Holdings (Group)'s Profit Performance

In conclusion, Sansheng Holdings (Group) has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Sansheng Holdings (Group)'s statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Sansheng Holdings (Group), you'd also look into what risks it is currently facing. To help with this, we've discovered 4 warning signs (2 don't sit too well with us!) that you ought to be aware of before buying any shares in Sansheng Holdings (Group).

Our examination of Sansheng Holdings (Group) has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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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