KFM Kingdom Holdings Limited's (HKG:3816) healthy profit numbers didn't contain any surprises for investors. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for KFM Kingdom Holdings

Examining Cashflow Against KFM Kingdom 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to March 2022, KFM Kingdom Holdings had an accrual ratio of 0.34. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of HK$82m, in contrast to the aforementioned profit of HK$13.2m. We saw that FCF was HK$42m a year ago though, so KFM Kingdom Holdings has at least been able to generate positive FCF in the past. The good news for shareholders is that KFM Kingdom Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. 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 KFM Kingdom Holdings.

Our Take On KFM Kingdom Holdings' Profit Performance

As we have made quite clear, we're a bit worried that KFM Kingdom Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that KFM Kingdom Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 52% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 2 warning signs for KFM Kingdom Holdings (1 doesn't sit too well with us!) and we strongly recommend you look at these before investing.

Today we've zoomed in on a single data point to better understand the nature of KFM Kingdom Holdings' 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 that insiders are buying 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.