Despite Desun Real Estate Investment Services Group Co., Ltd.'s (HKG:2270) recent earnings report having lackluster headline numbers, the market responded positively. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

View our latest analysis for Desun Real Estate Investment Services Group

A Closer Look At Desun Real Estate Investment Services Group's 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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".

Over the twelve months to June 2023, Desun Real Estate Investment Services Group recorded an accrual ratio of 1.83. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥44m despite its profit of CN¥25.7m, mentioned above. We also note that Desun Real Estate Investment Services Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥44m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Desun Real Estate Investment Services Group.

Our Take On Desun Real Estate Investment Services Group's Profit Performance

As we have made quite clear, we're a bit worried that Desun Real Estate Investment Services Group didn't back up the last year's profit with free cashflow. For this reason, we think that Desun Real Estate Investment Services Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing Desun Real Estate Investment Services Group at this point in time. Every company has risks, and we've spotted 5 warning signs for Desun Real Estate Investment Services Group (of which 3 are potentially serious!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Desun Real Estate Investment Services Group's profit. 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.