Should You Use Plover Bay Technologies' (HKG:1523) Statutory Earnings To Analyse It?

Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Plover Bay Technologies' (HKG:1523) statutory profits are a good guide to its underlying earnings.

While Plover Bay Technologies was able to generate revenue of US$48.0m in the last twelve months, we think its profit result of US$11.5m was more important. One positive is that it has grown both its profit and its revenue, over the last few years.

View our latest analysis for Plover Bay Technologies

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Plover Bay Technologies' cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Examining Cashflow Against Plover Bay Technologies' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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 2020, Plover Bay Technologies recorded an accrual ratio of 0.27. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of US$9.6m in the last year, which was a lot less than its statutory profit of US$11.5m. Plover Bay Technologies' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. The good news for shareholders is that Plover Bay Technologies' 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.

Our Take On Plover Bay Technologies' Profit Performance

Plover Bay Technologies didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Plover Bay Technologies' statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 65% over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Our analysis shows 5 warning signs for Plover Bay Technologies (1 is a bit unpleasant!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Plover Bay Technologies' 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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