Redco Healthy Living's (HKG:2370) Sluggish Earnings Might Be Just The Beginning Of Its Problems

Redco Healthy Living Company Limited's (HKG:2370) recent weak earnings report didn't cause a big stock movement. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out our latest analysis for Redco Healthy Living

Zooming In On Redco Healthy Living's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Redco Healthy Living has an accrual ratio of 0.29 for the year to June 2022. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In fact, it had free cash flow of CN¥5.6m in the last year, which was a lot less than its statutory profit of CN¥30.6m. Redco Healthy Living shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Redco Healthy Living.

Our Take On Redco Healthy Living's Profit Performance

Redco Healthy Living didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Redco Healthy Living's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 47% per annum growth in EPS for the last three. 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. If you'd like to know more about Redco Healthy Living as a business, it's important to be aware of any risks it's facing. When we did our research, we found 4 warning signs for Redco Healthy Living (2 are potentially serious!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Redco Healthy Living's 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.