The subdued market reaction suggests that Redco Healthy Living Company Limited's (HKG:2370) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Redco Healthy Living

Examining Cashflow Against Redco Healthy Living's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

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. 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".

Redco Healthy Living has an accrual ratio of 0.29 for the year to June 2022. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Indeed, in the last twelve months it reported free cash flow of CN¥5.6m, which is significantly less than its profit of CN¥30.6m. Redco Healthy Living shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down 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 Redco Healthy Living.

Our Take On Redco Healthy Living's Profit Performance

Redco Healthy Living's 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 Redco Healthy Living's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 47% over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Redco Healthy Living, you'd also look into what risks it is currently facing. When we did our research, we found 4 warning signs for Redco Healthy Living (2 don't sit too well with us!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Redco Healthy Living's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.