Shareholders appeared to be happy with Man Shing Global Holdings Limited's (HKG:8309) solid earnings report last week. Looking deeper at the numbers, we found several encouraging factors beyond the headline profit numbers.

View our latest analysis for Man Shing Global Holdings

Examining Cashflow Against Man Shing Global 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. 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. 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 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.

Man Shing Global Holdings has an accrual ratio of -0.58 for the year to September 2022. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$75m during the period, dwarfing its reported profit of HK$17.6m. Given that Man Shing Global Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$75m would seem to be a step in the right direction. 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 Man Shing Global Holdings.

How Do Unusual Items Influence Profit?

Surprisingly, given Man Shing Global Holdings' accrual ratio implied strong cash conversion, its paper profit was actually boosted by HK$3.6m 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. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Man Shing Global Holdings doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Man Shing Global Holdings' Profit Performance

Man Shing Global 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. Based on these factors, we think that Man Shing Global Holdings' profits are a reasonably conservative guide to its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Man Shing Global Holdings has 2 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.

Our examination of Man Shing Global 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. 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.