Despite posting some strong earnings, the market for Channel Micron Holdings Company Limited's (HKG:2115) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

Check out our latest analysis for Channel Micron Holdings

A Closer Look At Channel Micron 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Channel Micron Holdings has an accrual ratio of 0.51 for the year to June 2022. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥20m, in contrast to the aforementioned profit of CN¥64.5m. We also note that Channel Micron Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥20m.

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

Our Take On Channel Micron Holdings' Profit Performance

As we discussed above, we think Channel Micron Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Channel Micron Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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. 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 4 warning signs for Channel Micron Holdings (of which 1 is potentially serious!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Channel Micron Holdings' profit. But there are plenty of other ways to inform your opinion of a company. 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.