The market for Convenience Retail Asia Limited's (HKG:831) shares didn't move much after it posted weak earnings recently. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Examining Cashflow Against Convenience Retail Asia'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 December 2023, Convenience Retail Asia recorded an accrual ratio of -0.29. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of HK$181m in the last year, which was a lot more than its statutory profit of HK$57.7m. Convenience Retail Asia shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Convenience Retail Asia.

Our Take On Convenience Retail Asia's Profit Performance

As we discussed above, Convenience Retail Asia's 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 Convenience Retail Asia'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. So while earnings quality is important, it's equally important to consider the risks facing Convenience Retail Asia at this point in time. To help with this, we've discovered 3 warning signs (1 makes us a bit uncomfortable!) that you ought to be aware of before buying any shares in Convenience Retail Asia.

This note has only looked at a single factor that sheds light on the nature of Convenience Retail Asia's profit. But there are plenty of other ways to inform your opinion of a company. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.