Investors were underwhelmed by the solid earnings posted by Tongcheng Travel Holdings Limited (HKG:780) recently. Our analysis says that investors should be optimistic, as the strong profit is built on solid foundations.
Examining Cashflow Against Tongcheng Travel 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to December 2023, Tongcheng Travel Holdings had an accrual ratio of -0.14. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥3.2b during the period, dwarfing its reported profit of CN¥1.55b. Given that Tongcheng Travel Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥3.2b would seem to be a step in the right direction.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
Our Take On Tongcheng Travel Holdings' Profit Performance
Tongcheng Travel Holdings' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Tongcheng Travel Holdings' earnings potential is at least as good as it seems, and maybe even better! And it's also positive that 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. At Simply Wall St, we found 1 warning sign for Tongcheng Travel Holdings and we think they deserve your attention.
Today we've zoomed in on a single data point to better understand the nature of Tongcheng Travel Holdings' 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.