Tree Holdings' (HKG:8395) Performance Is Even Better Than Its Earnings Suggest

When companies post strong earnings, the stock generally performs well, just like Tree Holdings Limited's (HKG:8395) stock has recently. We did some digging and found some further encouraging factors that investors will like.

View our latest analysis for Tree Holdings

Zooming In On Tree Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Tree Holdings has an accrual ratio of -0.51 for the year to March 2021. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$35m in the last year, which was a lot more than its statutory profit of HK$14.6m. Tree Holdings' 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 Tree Holdings.

Our Take On Tree Holdings' Profit Performance

Happily for shareholders, Tree Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Tree Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. 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. Case in point: We've spotted 2 warning signs for Tree Holdings you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Tree Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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