Shareholders appeared unconcerned with Chinney Kin Wing Holdings Limited's (HKG:1556) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

See our latest analysis for Chinney Kin Wing Holdings

Examining Cashflow Against Chinney Kin Wing Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Chinney Kin Wing Holdings has an accrual ratio of -0.29 for the year to December 2021. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of HK$174m in the last year, which was a lot more than its statutory profit of HK$66.7m. Chinney Kin Wing Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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

Our Take On Chinney Kin Wing Holdings' Profit Performance

Happily for shareholders, Chinney Kin Wing Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Chinney Kin Wing Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 16% annually, over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Chinney Kin Wing Holdings has 4 warning signs (and 1 which is concerning) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Chinney Kin Wing 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 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.