The market seemed underwhelmed by the solid earnings posted by Ganso Co., Ltd. (SHSE:603886) recently. We have done some analysis, and found some encouraging factors that we believe the shareholders should consider.
Examining Cashflow Against Ganso's Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to December 2023, Ganso had an accrual ratio of -7.22. 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¥424m during the period, dwarfing its reported profit of CN¥276.3m. Ganso's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.
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 Ganso's Profit Performance
Happily for shareholders, Ganso produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Ganso's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! 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. So while earnings quality is important, it's equally important to consider the risks facing Ganso at this point in time. Every company has risks, and we've spotted 1 warning sign for Ganso you should know about.
Today we've zoomed in on a single data point to better understand the nature of Ganso's 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.
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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.