The subdued market reaction suggests that Changhong Jiahua Holdings Limited's (HKG:3991) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

Zooming In On Changhong Jiahua Holdings' 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. 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.

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.

Changhong Jiahua Holdings has an accrual ratio of 0.81 for the year to December 2023. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of HK$360.5m, a look at free cash flow indicates it actually burnt through HK$2.9b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$2.9b, this year, indicates high risk.

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

Our Take On Changhong Jiahua Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Changhong Jiahua Holdings didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Changhong Jiahua Holdings' underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. If you want to do dive deeper into Changhong Jiahua Holdings, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Changhong Jiahua Holdings (1 is a bit unpleasant!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Changhong Jiahua 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. 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.