E. Bon Holdings Limited's (HKG:599) solid earnings announcement recently didn't do much to the stock price. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

Check out our latest analysis for E. Bon Holdings

Examining Cashflow Against E. Bon 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

E. Bon Holdings has an accrual ratio of -0.13 for the year to March 2022. 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$66m in the last year, which was a lot more than its statutory profit of HK$11.9m. E. Bon 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 E. Bon Holdings.

Our Take On E. Bon Holdings' Profit Performance

E. Bon Holdings' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that E. Bon Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 10% 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. So while earnings quality is important, it's equally important to consider the risks facing E. Bon Holdings at this point in time. For instance, we've identified 3 warning signs for E. Bon Holdings (1 is a bit unpleasant) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of E. Bon 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.