Statutory Profit Doesn't Reflect How Good CircuTech International Holdings' (HKG:8051) Earnings Are

Even though CircuTech International Holdings Limited's (HKG:8051) recent earnings release was robust, the market didn't seem to notice. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for CircuTech International Holdings

Examining Cashflow Against CircuTech International Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2020, CircuTech International Holdings had an accrual ratio of -0.61. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$42m during the period, dwarfing its reported profit of HK$9.00m. Given that CircuTech International Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$42m would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that CircuTech International Holdings' profit was boosted by unusual items worth HK$1.0m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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 CircuTech International Holdings' Profit Performance

In conclusion, CircuTech International Holdings' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that CircuTech International Holdings' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing CircuTech International Holdings at this point in time. Case in point: We've spotted 2 warning signs for CircuTech International Holdings you should be aware of.

Our examination of CircuTech International Holdings has focussed on certain factors that can make its earnings look better than they are. 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. 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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