Why Wai Chi Holdings' (HKG:1305) Shaky Earnings Are Just The Beginning Of Its Problems

Investors were disappointed by Wai Chi Holdings Company Limited's (HKG:1305 ) latest earnings release. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

See our latest analysis for Wai Chi Holdings

Examining Cashflow Against Wai Chi 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Wai Chi Holdings has an accrual ratio of 0.33 for the year to December 2023. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In the last twelve months it actually had negative free cash flow, with an outflow of HK$242m despite its profit of HK$36.4m, mentioned above. We saw that FCF was HK$269m a year ago though, so Wai Chi Holdings has at least been able to generate positive FCF in the past. The good news for shareholders is that Wai Chi Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

Our Take On Wai Chi Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Wai Chi Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Wai Chi Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Nonetheless, it's still worth noting that its earnings per share have grown at 18% over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Wai Chi Holdings at this point in time. For example, we've found that Wai Chi Holdings has 3 warning signs (1 is significant!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Wai Chi Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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. 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.