Trio Industrial Electronics Group's (HKG:1710) Soft Earnings Are Actually Better Than They Appear

The market was pleased with the recent earnings report from Trio Industrial Electronics Group Limited (HKG:1710), despite the profit numbers being soft. However, we think the company is showing some signs that things are more promising than they seem.

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Examining Cashflow Against Trio Industrial Electronics Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Trio Industrial Electronics Group has an accrual ratio of -0.21 for the year to December 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$80m in the last year, which was a lot more than its statutory profit of HK$8.56m. Trio Industrial Electronics Group's free cash flow improved over the last year, which is generally good to see. However, as we will discuss below, we can see that the company's accrual ratio has been impacted by its tax situation.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Trio Industrial Electronics Group.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Trio Industrial Electronics Group profited from a tax benefit which contributed HK$1.2m to profit. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! We're sure the company was pleased with its tax benefit. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Trio Industrial Electronics Group's Profit Performance

In conclusion, Trio Industrial Electronics Group has strong cashflow relative to earnings, which indicates good quality earnings, but the tax benefit means its profit wasn't as sustainable as we'd like to see. Considering all the aforementioned, we'd venture that Trio Industrial Electronics Group's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into Trio Industrial Electronics Group, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 3 warning signs for Trio Industrial Electronics Group 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 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.