Shareholders Can Be Confident That Hong Kong Television Network's (HKG:1137) Earnings Are High Quality

Hong Kong Television Network Limited (HKG:1137) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

Check out our latest analysis for Hong Kong Television Network

Examining Cashflow Against Hong Kong Television Network'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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

For the year to December 2020, Hong Kong Television Network had an accrual ratio of -0.25. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$520m during the period, dwarfing its reported profit of HK$183.6m. Notably, Hong Kong Television Network had negative free cash flow last year, so the HK$520m it produced this year was a welcome improvement. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Hong Kong Television Network's profit was boosted by unusual items worth HK$59m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. We can see that Hong Kong Television Network's positive unusual items were quite significant relative to its profit in the year to December 2020. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Hong Kong Television Network's Profit Performance

Hong Kong Television Network's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Hong Kong Television Network's profits are an apt reflection of its underlying potential for profit. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. While conducting our analysis, we found that Hong Kong Television Network has 2 warning signs and it would be unwise to ignore these.

Our examination of Hong Kong Television Network has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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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