The subdued market reaction suggests that Winson Holdings Hong Kong Limited's (HKG:6812) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

Examining Cashflow Against Winson Holdings Hong Kong'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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, Winson Holdings Hong Kong recorded an accrual ratio of 0.70. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of HK$51m despite its profit of HK$10.9m, mentioned above. We saw that FCF was HK$47m a year ago though, so Winson Holdings Hong Kong has at least been able to generate positive FCF in the past. One positive for Winson Holdings Hong Kong shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On Winson Holdings Hong Kong's Profit Performance

As we have made quite clear, we're a bit worried that Winson Holdings Hong Kong didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Winson Holdings Hong Kong's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Winson Holdings Hong Kong as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with Winson Holdings Hong Kong (including 2 which can't be ignored).

This note has only looked at a single factor that sheds light on the nature of Winson Holdings Hong Kong's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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