Unsurprisingly, Apex Ace Holding Limited's (HKG:6036) stock price was strong on the back of its healthy earnings report. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.
Zooming In On Apex Ace Holding'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. 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.
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. 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.
Over the twelve months to June 2021, Apex Ace Holding recorded an accrual ratio of 0.40. 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. Over the last year it actually had negative free cash flow of HK$205m, in contrast to the aforementioned profit of HK$20.5m. We also note that Apex Ace Holding's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$205m.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Apex Ace Holding.
Our Take On Apex Ace Holding's Profit Performance
As we have made quite clear, we're a bit worried that Apex Ace Holding didn't back up the last year's profit with free cashflow. For this reason, we think that Apex Ace Holding's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Apex Ace Holding is showing 5 warning signs in our investment analysis and 3 of those shouldn't be ignored...
This note has only looked at a single factor that sheds light on the nature of Apex Ace Holding's 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. 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.
Valuation is complex, but we're helping make it simple.
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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.
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