BOE Varitronix's (HKG:710) Soft Earnings Don't Show The Whole Picture

Investors were disappointed with the weak earnings posted by BOE Varitronix Limited (HKG:710 ). While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

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Examining Cashflow Against BOE Varitronix's 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). 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.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2024, BOE Varitronix recorded an accrual ratio of -0.43. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$880m in the last year, which was a lot more than its statutory profit of HK$391.3m. BOE Varitronix's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Check out our latest analysis for BOE Varitronix

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.

The Impact Of Unusual Items On Profit

Surprisingly, given BOE Varitronix's accrual ratio implied strong cash conversion, its paper profit was actually boosted by HK$36m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On BOE Varitronix's Profit Performance

BOE Varitronix's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that BOE Varitronix's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about BOE Varitronix as a business, it's important to be aware of any risks it's facing. For example - BOE Varitronix has 2 warning signs we think you should be aware of.

Our examination of BOE Varitronix has focussed on certain factors that can make its earnings look better than they are. 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.