The market seemed underwhelmed by last week's earnings announcement from Asia Commercial Holdings Limited (HKG:104) despite the healthy numbers. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

See our latest analysis for Asia Commercial Holdings

Zooming In On Asia Commercial Holdings' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2022, Asia Commercial Holdings had an accrual ratio of -0.20. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$165m in the last year, which was a lot more than its statutory profit of HK$83.8m. Asia Commercial 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.

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

The Impact Of Unusual Items On Profit

Surprisingly, given Asia Commercial Holdings' accrual ratio implied strong cash conversion, its paper profit was actually boosted by HK$29m 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. And, after all, that's exactly what the accounting terminology implies. We can see that Asia Commercial Holdings' positive unusual items were quite significant relative to its profit in the year to March 2022. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Asia Commercial Holdings' Profit Performance

Asia Commercial 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 the aforementioned, we think that Asia Commercial Holdings' profits are probably a reasonable reflection of its underlying profitability; although we'd be confident in that conclusion if we saw a cleaner set of results. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. When we did our research, we found 5 warning signs for Asia Commercial Holdings (1 doesn't sit too well with us!) that we believe deserve your full attention.

Our examination of Asia Commercial Holdings has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.