Smart-Core Holdings Limited's (HKG:2166) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.
Examining Cashflow Against Smart-Core 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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".
Smart-Core Holdings has an accrual ratio of -0.10 for the year to December 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of HK$215m in the last year, which was a lot more than its statutory profit of HK$100.3m. Smart-Core Holdings' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Smart-Core Holdings.
Our Take On Smart-Core Holdings' Profit Performance
As we discussed above, Smart-Core Holdings has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Smart-Core Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 42% in the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Smart-Core Holdings.
This note has only looked at a single factor that sheds light on the nature of Smart-Core 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. 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.