Fulu Holdings' (HKG:2101) Earnings Are Weaker Than They Seem

Fulu Holdings Limited's (HKG:2101) stock was strong after they reported robust earnings. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

See our latest analysis for Fulu Holdings

Examining Cashflow Against Fulu Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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.

Fulu Holdings has an accrual ratio of 0.56 for the year to December 2020. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥187m despite its profit of CN¥120.9m, mentioned above. We saw that FCF was CN¥50m a year ago though, so Fulu Holdings has at least been able to generate positive FCF in the past.

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

Our Take On Fulu Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Fulu Holdings didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Fulu Holdings' underlying earnings power is lower than its statutory profit. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Fulu Holdings has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Fulu Holdings' 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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