Investors were underwhelmed by the solid earnings posted by Wise Ally International Holdings Limited (HKG:9918) recently. We have done some analysis and have found some comforting factors beneath the profit numbers.
Zooming In On Wise Ally International Holdings' Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.
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".
Wise Ally International Holdings has an accrual ratio of -0.57 for the year to December 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of HK$150m in the last year, which was a lot more than its statutory profit of HK$72.2m. Wise Ally International Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
Check out our latest analysis for Wise Ally International Holdings
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wise Ally International Holdings.
The Impact Of Unusual Items On Profit
Surprisingly, given Wise Ally International Holdings' accrual ratio implied strong cash conversion, its paper profit was actually boosted by HK$19m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).
Our Take On Wise Ally International Holdings' Profit Performance
Wise Ally International Holdings' profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that Wise Ally International 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 Wise Ally International Holdings at this point in time. Be aware that Wise Ally International Holdings is showing 3 warning signs in our investment analysis and 1 of those is a bit concerning...
In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.
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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.