China Sandi Holdings Limited's (HKG:910) stock was strong despite it releasing a soft earnings report last week. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.

View our latest analysis for China Sandi Holdings

A Closer Look At China Sandi Holdings' 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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 June 2022, China Sandi Holdings had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥1.8b, well over the CN¥80.7m it reported in profit. Notably, China Sandi Holdings had negative free cash flow last year, so the CN¥1.8b 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 China Sandi Holdings.

Our Take On China Sandi Holdings' Profit Performance

As we discussed above, China Sandi Holdings has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that China Sandi Holdings' 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 3 warning signs for China Sandi Holdings (1 is a bit unpleasant!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of China Sandi 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 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.