Gemdale Properties and Investment's (HKG:535) Earnings Are Growing But Is There More To The Story?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Gemdale Properties and Investment's (HKG:535) statutory profits are a good guide to its underlying earnings.

We like the fact that Gemdale Properties and Investment made a profit of CN¥4.25b on its revenue of CN¥14.3b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Gemdale Properties and Investment

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Gemdale Properties and Investment's cashflow tells 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 Gemdale Properties and Investment.

Examining Cashflow Against Gemdale Properties and Investment'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2020, Gemdale Properties and Investment recorded an accrual ratio of -0.18. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥8.6b during the period, dwarfing its reported profit of CN¥4.25b. Gemdale Properties and Investment shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Gemdale Properties and Investment's Profit Performance

Happily for shareholders, Gemdale Properties and Investment produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Gemdale Properties and Investment's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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 - Gemdale Properties and Investment has 3 warning signs we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Gemdale Properties and Investment's 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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