Should You Use Guorui Properties's (HKG:2329) Statutory Earnings To Analyse It?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Guorui Properties' (HKG:2329) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Guorui Properties made a profit of CN¥502.5m on revenue of CN¥7.64b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

See our latest analysis for Guorui Properties

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Guorui Properties' cashflow and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guorui Properties.

Zooming In On Guorui Properties' 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'.

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. 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.

Guorui Properties has an accrual ratio of -0.11 for the year to June 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of CN¥5.4b during the period, dwarfing its reported profit of CN¥502.5m. Guorui Properties' free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Guorui Properties' profit was boosted by unusual items worth CN¥770m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Guorui Properties' positive unusual items were quite significant relative to its profit in the year to June 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Guorui Properties' Profit Performance

In conclusion, Guorui Properties' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think it's very unlikely that Guorui Properties' statutory profits make it seem much weaker than it is. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Guorui Properties has 5 warning signs (and 2 which are a bit unpleasant) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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. 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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