Rich Honour International Designs' (TWSE:6754) Strong Earnings Are Of Good Quality

Rich Honour International Designs Co., Ltd. (TWSE:6754) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Check out our latest analysis for Rich Honour International Designs

A Closer Look At Rich Honour International Designs' 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2024, Rich Honour International Designs had an accrual ratio of -0.34. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of NT$697m during the period, dwarfing its reported profit of NT$412.4m. Rich Honour International Designs' free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Rich Honour International Designs.

Our Take On Rich Honour International Designs' Profit Performance

As we discussed above, Rich Honour International Designs' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Rich Honour International Designs' statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you're interested we have a graphic representation of Rich Honour International Designs' balance sheet.

This note has only looked at a single factor that sheds light on the nature of Rich Honour International Designs' profit. But there are plenty of other ways to inform your opinion of a company. 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.