Shareholders appeared unconcerned with Winson Holdings Hong Kong Limited's (HKG:6812) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for Winson Holdings Hong Kong

Examining Cashflow Against Winson Holdings Hong Kong's 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.

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".

For the year to March 2022, Winson Holdings Hong Kong had an accrual ratio of -0.13. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of HK$33m during the period, dwarfing its reported profit of HK$22.1m. Winson Holdings Hong Kong's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

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

Our Take On Winson Holdings Hong Kong's Profit Performance

As we discussed above, Winson Holdings Hong Kong has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Winson Holdings Hong Kong's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 6.0% per year 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. If you want to do dive deeper into Winson Holdings Hong Kong, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 3 warning signs with Winson Holdings Hong Kong, and understanding these should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Winson Holdings Hong Kong's 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.