China PengFei Group Limited (HKG:3348) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.
A Closer Look At China PengFei Group's 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
China PengFei Group has an accrual ratio of 0.26 for the year to December 2023. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Indeed, in the last twelve months it reported free cash flow of CN¥21m, which is significantly less than its profit of CN¥142.9m. Notably, China PengFei Group had negative free cash flow last year, so the CN¥21m 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 PengFei Group.
Our Take On China PengFei Group's Profit Performance
China PengFei Group didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that China PengFei Group's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 8.3% over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about China PengFei Group as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for China PengFei Group (1 doesn't sit too well with us) you should be familiar with.
Today we've zoomed in on a single data point to better understand the nature of China PengFei Group's 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. 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.
