We Think Ulferts International's (HKG:1711) Robust Earnings Are Conservative

Even though Ulferts International Limited (HKG:1711 ) posted strong earnings, investors appeared to be underwhelmed. We did some digging and actually think they are being unnecessarily pessimistic.

Check out our latest analysis for Ulferts International

A Closer Look At Ulferts International'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 March 2021, Ulferts International recorded an accrual ratio of -2.07. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$76m during the period, dwarfing its reported profit of HK$16.8m. Ulferts International's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ulferts International.

Our Take On Ulferts International's Profit Performance

Happily for shareholders, Ulferts International produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Ulferts International's statutory profit actually understates its earnings potential! And one can definitely find a positive in the fact that it made a profit this year, despite losing money last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 3 warning signs for Ulferts International (1 is significant) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Ulferts International'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. 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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