China Display Optoelectronics Technology Holdings' (HKG:334) Solid Earnings Have Been Accounted For Conservatively

Despite posting healthy earnings, China Display Optoelectronics Technology Holdings Limited's (HKG:334 ) stock has been quite weak. Our analysis suggests that there are some reasons for hope that investors should be aware of.

See our latest analysis for China Display Optoelectronics Technology Holdings

A Closer Look At China Display Optoelectronics Technology 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

China Display Optoelectronics Technology Holdings has an accrual ratio of -0.59 for the year to June 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥402m during the period, dwarfing its reported profit of CN¥27.5m. Given that China Display Optoelectronics Technology Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥402m would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Display Optoelectronics Technology Holdings.

Our Take On China Display Optoelectronics Technology Holdings' Profit Performance

Happily for shareholders, China Display Optoelectronics Technology Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that China Display Optoelectronics Technology Holdings' statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for China Display Optoelectronics Technology Holdings you should be mindful of and 1 of these bad boys is a bit unpleasant.

This note has only looked at a single factor that sheds light on the nature of China Display Optoelectronics Technology Holdings' profit. 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. 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.