A lackluster earnings announcement from Kwong Luen Engineering Holdings Limited (HKG:1413) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

Check out our latest analysis for Kwong Luen Engineering Holdings

Zooming In On Kwong Luen Engineering Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Kwong Luen Engineering Holdings has an accrual ratio of 0.52 for the year to March 2022. 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. Over the last year it actually had negative free cash flow of HK$69m, in contrast to the aforementioned profit of HK$23.5m. We also note that Kwong Luen Engineering Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$69m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kwong Luen Engineering Holdings.

Our Take On Kwong Luen Engineering Holdings' Profit Performance

As we discussed above, we think Kwong Luen Engineering Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Kwong Luen Engineering Holdings' underlying earnings power is lower than its statutory profit. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Every company has risks, and we've spotted 3 warning signs for Kwong Luen Engineering Holdings (of which 1 is concerning!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Kwong Luen Engineering 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.