Despite posting some strong earnings, the market for Loco Hong Kong Holdings Limited's (HKG:8162) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

Examining Cashflow Against Loco Hong Kong Holdings' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2024, Loco Hong Kong Holdings recorded an accrual ratio of 0.48. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of HK$801k during the period, falling well short of its reported profit of HK$22.7m. Notably, Loco Hong Kong Holdings had negative free cash flow last year, so the HK$801k it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Loco Hong Kong Holdings.

Our Take On Loco Hong Kong Holdings' Profit Performance

As we discussed above, we think Loco Hong Kong Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Loco Hong Kong Holdings' underlying earnings power is lower than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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 Loco Hong Kong Holdings as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Loco Hong Kong Holdings (of which 2 are potentially serious!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Loco Hong Kong Holdings' 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. 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.