Impressive Earnings May Not Tell The Whole Story For FAR International Holdings Group (HKG:2516)

Investors were disappointed with FAR International Holdings Group Company Limited's (HKG:2516) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

Check out our latest analysis for FAR International Holdings Group

Examining Cashflow Against FAR International Holdings Group'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

FAR International Holdings Group has an accrual ratio of 0.77 for the year to June 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥322m despite its profit of CN¥54.1m, mentioned above. We also note that FAR International Holdings Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥322m.

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

Our Take On FAR International Holdings Group's Profit Performance

As we discussed above, we think FAR International Holdings Group's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that FAR International Holdings Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. 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'd like to know more about FAR International Holdings Group as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for FAR International Holdings Group you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of FAR International Holdings Group's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with high insider ownership.

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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.