Are Kim Hin Joo (Malaysia) Berhad's (KLSE:KHJB) Statutory Earnings A Good Guide To Its Underlying Profitability?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Kim Hin Joo (Malaysia) Berhad's (KLSE:KHJB) statutory profits are a good guide to its underlying earnings.

We like the fact that Kim Hin Joo (Malaysia) Berhad made a profit of RM7.27m on its revenue of RM89.5m, in the last year. As you can see below, its profit has actually declined over the last three years, even though its revenue was flat.

Check out our latest analysis for Kim Hin Joo (Malaysia) 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. Today, we'll discuss Kim Hin Joo (Malaysia) Berhad's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kim Hin Joo (Malaysia) Berhad.

Zooming In On Kim Hin Joo (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. 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 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 September 2020, Kim Hin Joo (Malaysia) Berhad had an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of RM12m, well over the RM7.27m it reported in profit. Kim Hin Joo (Malaysia) Berhad's free cash flow improved over the last year, which is generally good to see.

Our Take On Kim Hin Joo (Malaysia) Berhad's Profit Performance

As we discussed above, Kim Hin Joo (Malaysia) Berhad has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Kim Hin Joo (Malaysia) Berhad's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over 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. If you want to do dive deeper into Kim Hin Joo (Malaysia) Berhad, you'd also look into what risks it is currently facing. When we did our research, we found 4 warning signs for Kim Hin Joo (Malaysia) Berhad (1 is significant!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Kim Hin Joo (Malaysia) 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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