We Think DKSH Holdings (Malaysia) Berhad's (KLSE:DKSH) Profit Is Only A Baseline For What They Can Achieve

The subdued stock price reaction suggests that DKSH Holdings (Malaysia) Berhad's (KLSE:DKSH) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

See our latest analysis for DKSH Holdings (Malaysia) Berhad

Zooming In On DKSH Holdings (Malaysia) Berhad's 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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".

Over the twelve months to September 2021, DKSH Holdings (Malaysia) Berhad recorded an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of RM228m during the period, dwarfing its reported profit of RM78.3m. DKSH Holdings (Malaysia) Berhad shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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.

Our Take On DKSH Holdings (Malaysia) Berhad's Profit Performance

As we discussed above, DKSH Holdings (Malaysia) Berhad has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that DKSH Holdings (Malaysia) Berhad's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 58% per year over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing DKSH Holdings (Malaysia) Berhad at this point in time. In terms of investment risks, we've identified 3 warning signs with DKSH Holdings (Malaysia) Berhad, and understanding these should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of DKSH Holdings (Malaysia) Berhad's 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. 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.