Investors were disappointed with Vietnam Manufacturing and Export Processing (Holdings) Limited's (HKG:422) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

Check out our latest analysis for Vietnam Manufacturing and Export Processing (Holdings)

Examining Cashflow Against Vietnam Manufacturing and Export Processing (Holdings)'s Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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 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 2023, Vietnam Manufacturing and Export Processing (Holdings) had an accrual ratio of 0.29. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In the last twelve months it actually had negative free cash flow, with an outflow of US$7.2m despite its profit of US$3.94m, mentioned above. We saw that FCF was US$2.4m a year ago though, so Vietnam Manufacturing and Export Processing (Holdings) has at least been able to generate positive FCF in the past. The good news for shareholders is that Vietnam Manufacturing and Export Processing (Holdings)'s accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Vietnam Manufacturing and Export Processing (Holdings).

Our Take On Vietnam Manufacturing and Export Processing (Holdings)'s Profit Performance

Vietnam Manufacturing and Export Processing (Holdings)'s accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Vietnam Manufacturing and Export Processing (Holdings)'s true underlying earnings power is actually less than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Vietnam Manufacturing and Export Processing (Holdings) as a business, it's important to be aware of any risks it's facing. When we did our research, we found 2 warning signs for Vietnam Manufacturing and Export Processing (Holdings) (1 is potentially serious!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Vietnam Manufacturing and Export Processing (Holdings)'s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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. 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.