Investors Can Find Comfort In Oriental Watch Holdings' (HKG:398) Earnings Quality

Shareholders appeared unconcerned with Oriental Watch Holdings Limited's (HKG:398) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

See our latest analysis for Oriental Watch Holdings

Examining Cashflow Against Oriental Watch Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Oriental Watch Holdings has an accrual ratio of -0.12 for the year to September 2024. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of HK$314m during the period, dwarfing its reported profit of HK$231.8m. Oriental Watch Holdings did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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

Our Take On Oriental Watch Holdings' Profit Performance

As we discussed above, Oriental Watch Holdings has perfectly satisfactory free cash flow relative to profit. Because of this, we think Oriental Watch Holdings' earnings potential is at least as good as it seems, and maybe even better! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you want to do dive deeper into Oriental Watch Holdings, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Oriental Watch Holdings has 1 warning sign and it would be unwise to ignore this.

Today we've zoomed in on a single data point to better understand the nature of Oriental Watch 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 with high insider ownership.

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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.