The subdued stock price reaction suggests that KPa-BM Holdings Limited's (HKG:2663) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Zooming In On KPa-BM Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to March 2024, KPa-BM Holdings had an accrual ratio of -0.39. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of HK$107m in the last year, which was a lot more than its statutory profit of HK$46.4m. KPa-BM Holdings' 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 KPa-BM Holdings.

Our Take On KPa-BM Holdings' Profit Performance

As we discussed above, KPa-BM Holdings' 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 KPa-BM Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 33% in 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. If you'd like to know more about KPa-BM Holdings as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for KPa-BM Holdings (1 makes us a bit uncomfortable) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of KPa-BM Holdings' 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 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