DTXS Silk Road Investment Holdings' (HKG:620) Solid Earnings Have Been Accounted For Conservatively

The market seemed underwhelmed by last week's earnings announcement from DTXS Silk Road Investment Holdings Company Limited (HKG:620) despite the healthy numbers. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

View our latest analysis for DTXS Silk Road Investment Holdings

Zooming In On DTXS Silk Road Investment 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 2021, DTXS Silk Road Investment Holdings recorded an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of HK$485m despite its profit of HK$8.59m, mentioned above. We also note that DTXS Silk Road Investment Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$485m. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

The Impact Of Unusual Items On Profit

On top of the noteworthy accrual ratio and the spike in non-operating revenue, we can also see that DTXS Silk Road Investment Holdings suffered from unusual items, which reduced profit by HK$4.6m in the last twelve months. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If DTXS Silk Road Investment Holdings doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On DTXS Silk Road Investment Holdings' Profit Performance

In conclusion, DTXS Silk Road Investment Holdings' accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. After taking into account all these factors, we think that DTXS Silk Road Investment Holdings' statutory results are a decent reflection of its underlying earnings power. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Every company has risks, and we've spotted 3 warning signs for DTXS Silk Road Investment Holdings (of which 2 are concerning!) you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.

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.

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