Are Tongda Group Holdings's (HKG:698) Statutory Earnings A Good Guide To Its Underlying Profitability?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Tongda Group Holdings (HKG:698).

We like the fact that Tongda Group Holdings made a profit of HK$114.8m on its revenue of HK$9.27b, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

View our latest analysis for Tongda Group Holdings

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Tongda Group Holdings' free cashflow relative to its earnings, and consider what that tells us about the company. 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.

A Closer Look At Tongda Group 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 2020, Tongda Group Holdings had an accrual ratio of -0.11. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of HK$1.1b in the last year, which was a lot more than its statutory profit of HK$114.8m. Notably, Tongda Group Holdings had negative free cash flow last year, so the HK$1.1b it produced this year was a welcome improvement.

Our Take On Tongda Group Holdings' Profit Performance

Tongda Group Holdings' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Tongda Group Holdings' statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you want to do dive deeper into Tongda Group Holdings, you'd also look into what risks it is currently facing. For instance, we've identified 2 warning signs for Tongda Group Holdings (1 is concerning) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Tongda Group Holdings' profit. But there are plenty of other ways to inform your opinion of a company. 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. 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 that insiders are buying to be useful.

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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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