Changhong Jiahua Holdings' (HKG:3991) Profits May Not Reveal Underlying Issues

The recent earnings posted by Changhong Jiahua Holdings Limited (HKG:3991) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for Changhong Jiahua Holdings

Zooming In On Changhong Jiahua Holdings' 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to June 2024, Changhong Jiahua Holdings had an accrual ratio of 0.98. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of HK$3.6b despite its profit of HK$360.5m, mentioned above. We also note that Changhong Jiahua Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$3.6b.

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

Our Take On Changhong Jiahua Holdings' Profit Performance

As we discussed above, we think Changhong Jiahua Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Changhong Jiahua Holdings' underlying earnings power is lower than its statutory profit. The good news is that its earnings per share increased slightly in the last year. 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. If you want to do dive deeper into Changhong Jiahua Holdings, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Changhong Jiahua Holdings (2 are a bit unpleasant) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Changhong Jiahua 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 with high insider ownership.

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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.