We Wouldn't Rely On Chen Xing Development Holdings's (HKG:2286) Statutory Earnings As A Guide

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Chen Xing Development Holdings' (HKG:2286) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Chen Xing Development Holdings made a profit of CN¥78.2m on revenue of CN¥982.0m. As you can see below, its profit has actually declined over the last three years, even though its revenue was flat.

See our latest analysis for Chen Xing Development Holdings

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Chen Xing Development Holdings' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chen Xing Development Holdings.

Zooming In On Chen Xing Development 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. 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.

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

Over the twelve months to June 2020, Chen Xing Development Holdings recorded an accrual ratio of 0.77. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥1.6b despite its profit of CN¥78.2m, mentioned above. We saw that FCF was CN¥717m a year ago though, so Chen Xing Development Holdings has at least been able to generate positive FCF in the past. The good news for shareholders is that Chen Xing Development Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Our Take On Chen Xing Development Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Chen Xing Development Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Chen Xing Development Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 4 warning signs (3 are significant!) that you ought to be aware of before buying any shares in Chen Xing Development Holdings.

Today we've zoomed in on a single data point to better understand the nature of Chen Xing Development Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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