Soft earnings didn't appear to concern HK Asia Holdings Limited's (HKG:1723) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for HK Asia Holdings

Examining Cashflow Against HK Asia 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2023, HK Asia Holdings had an accrual ratio of -0.36. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of HK$29m in the last year, which was a lot more than its statutory profit of HK$8.99m. HK Asia Holdings' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. 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.

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

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that HK Asia Holdings' profit was boosted by unusual items worth HK$973k 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 that's as you'd expect, given these boosts are described as 'unusual'. If HK Asia Holdings doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On HK Asia Holdings' Profit Performance

In conclusion, HK Asia Holdings' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that HK Asia Holdings' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing HK Asia Holdings at this point in time. Be aware that HK Asia Holdings is showing 3 warning signs in our investment analysis and 1 of those shouldn't be ignored...

Our examination of HK Asia Holdings has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.