The subdued market reaction suggests that Chi Ho Development Holdings Limited's (HKG:8423) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for Chi Ho Development Holdings

Zooming In On Chi Ho Development 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). 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.

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".

Over the twelve months to March 2022, Chi Ho Development Holdings recorded an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of HK$8.02m, a look at free cash flow indicates it actually burnt through HK$25m in the last year. We saw that FCF was HK$8.1m a year ago though, so Chi Ho Development Holdings has at least been able to generate positive FCF in the past.

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

Our Take On Chi Ho Development Holdings' Profit Performance

Chi Ho Development Holdings' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Chi Ho Development Holdings' statutory profits are better than its underlying earnings power. Sadly, its EPS was down over the last twelve months. 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. For example, Chi Ho Development Holdings has 5 warning signs (and 2 which are potentially serious) we think you should know about.

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