Are Kein Hing International Berhad's (KLSE:KEINHIN) Statutory Earnings A Good Guide To Its Underlying Profitability?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. In this article, we'll look at how useful this year's statutory profit is, when analysing Kein Hing International Berhad (KLSE:KEINHIN).

While Kein Hing International Berhad was able to generate revenue of RM196.8m in the last twelve months, we think its profit result of RM4.11m was more important. Below, you can see that both its revenue and its profit have fallen over the last three years.

View our latest analysis for Kein Hing International Berhad

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Kein Hing International Berhad's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kein Hing International Berhad.

Examining Cashflow Against Kein Hing International 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. 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".

For the year to July 2020, Kein Hing International Berhad had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of RM20m in the last year, which was a lot more than its statutory profit of RM4.11m. Kein Hing International Berhad's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On Kein Hing International Berhad's Profit Performance

As we discussed above, Kein Hing International Berhad has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Kein Hing International Berhad's statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 26% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 3 warning signs for Kein Hing International Berhad (of which 1 makes us a bit uncomfortable!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Kein Hing International Berhad'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 that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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