Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Pan Hong Holdings Group's (SGX:P36) statutory profits are a good guide to its underlying earnings.
It's good to see that over the last twelve months Pan Hong Holdings Group made a profit of CN¥227.9m on revenue of CN¥1.22b.
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Pan Hong Holdings Group'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 Pan Hong Holdings Group.
Zooming In On Pan Hong Holdings Group'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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Over the twelve months to September 2020, Pan Hong Holdings Group recorded an accrual ratio of -0.22. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥319m during the period, dwarfing its reported profit of CN¥227.9m. Notably, Pan Hong Holdings Group had negative free cash flow last year, so the CN¥319m it produced this year was a welcome improvement.
Our Take On Pan Hong Holdings Group's Profit Performance
Happily for shareholders, Pan Hong Holdings Group produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Pan Hong Holdings Group's statutory profit actually understates its earnings potential! And the EPS is up 28% over the last twelve months. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. You'd be interested to know, that we found 1 warning sign for Pan Hong Holdings Group and you'll want to know about this.
Today we've zoomed in on a single data point to better understand the nature of Pan Hong 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 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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