Investors were disappointed with the weak earnings posted by Wah Sun Handbags International Holdings Limited (HKG:2683 ). While the headline numbers were soft, we believe that investors might be missing some encouraging factors.
See our latest analysis for Wah Sun Handbags International Holdings
Examining Cashflow Against Wah Sun Handbags International 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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
For the year to September 2023, Wah Sun Handbags International Holdings had an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of HK$45m during the period, dwarfing its reported profit of HK$22.1m. Wah Sun Handbags International Holdings' 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 Wah Sun Handbags International Holdings.
Our Take On Wah Sun Handbags International Holdings' Profit Performance
As we discussed above, Wah Sun Handbags International Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Wah Sun Handbags International Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. For instance, we've identified 4 warning signs for Wah Sun Handbags International Holdings (1 can't be ignored) you should be familiar with.
This note has only looked at a single factor that sheds light on the nature of Wah Sun Handbags International Holdings' 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.