Shareholders appeared unconcerned with PC Partner Group Limited's (HKG:1263) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.
Zooming In On PC Partner Group's 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. The ratio shows us how much a company's profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Over the twelve months to December 2023, PC Partner Group recorded an accrual ratio of -1.97. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of HK$3.5b, well over the HK$60.8m it reported in profit. PC Partner Group's free cash flow improved over the last year, which is generally good to see.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of PC Partner Group.
Our Take On PC Partner Group's Profit Performance
As we discussed above, PC Partner Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think PC Partner Group's 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. If you want to do dive deeper into PC Partner Group, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 2 warning signs with PC Partner Group, and understanding them should be part of your investment process.
This note has only looked at a single factor that sheds light on the nature of PC Partner Group's 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.