Truly International Holdings' (HKG:732) Conservative Accounting Might Explain Soft Earnings

Soft earnings didn't appear to concern Truly International Holdings Limited's (HKG:732) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

View our latest analysis for Truly International Holdings

Zooming In On Truly International 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 December 2023, Truly International Holdings recorded an accrual ratio of -0.28. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of HK$4.8b, well over the HK$262.8m it reported in profit. Truly International Holdings' 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.

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

How Do Unusual Items Influence Profit?

Truly International Holdings' profit was reduced by unusual items worth HK$127m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If Truly International Holdings doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Truly International Holdings' Profit Performance

In conclusion, both Truly International Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Truly International Holdings' statutory profit probably understates its earnings potential! So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Truly International Holdings has 3 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

Our examination of Truly International Holdings has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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.