Solid profit numbers didn't seem to be enough to please Hong Kong Economic Times Holdings Limited's (HKG:423) shareholders. Our analysis has found some concerning factors which weaken the profit's foundation.

Zooming In On Hong Kong Economic Times Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Hong Kong Economic Times Holdings has an accrual ratio of 0.21 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of HK$28m, in contrast to the aforementioned profit of HK$54.2m. It's worth noting that Hong Kong Economic Times Holdings generated positive FCF of HK$51m a year ago, so at least they've done it in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. The good news for shareholders is that Hong Kong Economic Times Holdings' 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 Hong Kong Economic Times Holdings.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Hong Kong Economic Times Holdings' profit was boosted by unusual items worth HK$110m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Hong Kong Economic Times Holdings had a rather significant contribution from unusual items relative to its profit to March 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Hong Kong Economic Times Holdings' Profit Performance

Summing up, Hong Kong Economic Times Holdings received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Hong Kong Economic Times Holdings' profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Hong Kong Economic Times Holdings, you'd also look into what risks it is currently facing. Case in point: We've spotted 4 warning signs for Hong Kong Economic Times Holdings you should be mindful of and 2 of these bad boys are significant.

Our examination of Hong Kong Economic Times Holdings has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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 with significant insider holdings 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com