Even though Wai Chi Holdings Company Limited (HKG:1305 ) posted strong earnings, investors appeared to be underwhelmed. We have done some analysis and have found some comforting factors beneath the profit numbers.

View our latest analysis for Wai Chi Holdings

A Closer Look At Wai Chi 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. 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'.

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 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.

Over the twelve months to December 2021, Wai Chi Holdings recorded an accrual ratio of -0.19. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of HK$230m in the last year, which was a lot more than its statutory profit of HK$51.5m. Wai Chi 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 Wai Chi Holdings.

Our Take On Wai Chi Holdings' Profit Performance

Happily for shareholders, Wai Chi Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Wai Chi Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 14% annually, over the last three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for Wai Chi Holdings you should be aware of.

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