The stock price didn't jump after Aoyuan Healthy Life Group Company Limited (HKG:3662) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.
View our latest analysis for Aoyuan Healthy Life Group
Zooming In On Aoyuan Healthy Life Group'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. 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. The ratio shows us how much a company's profit exceeds its FCF.
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. 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.
Over the twelve months to June 2023, Aoyuan Healthy Life Group recorded an accrual ratio of 0.70. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of CN¥867k during the period, falling well short of its reported profit of CN¥174.2m. Given that Aoyuan Healthy Life Group had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥867k would seem to be a step in the right direction. The good news for shareholders is that Aoyuan Healthy Life Group's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Aoyuan Healthy Life Group.
Our Take On Aoyuan Healthy Life Group's Profit Performance
As we have made quite clear, we're a bit worried that Aoyuan Healthy Life Group didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Aoyuan Healthy Life Group's underlying earnings power is lower than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. 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. When we did our research, we found 4 warning signs for Aoyuan Healthy Life Group (3 don't sit too well with us!) that we believe deserve your full attention.
Today we've zoomed in on a single data point to better understand the nature of Aoyuan Healthy Life Group's 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.