Wangfujing Group Co., Ltd. (SHSE:600859) just reported healthy earnings but the stock price didn't move much. Our analysis suggests that investors might be missing some promising details.
Examining Cashflow Against Wangfujing Group's 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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 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, Wangfujing Group recorded an accrual ratio of -0.18. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥2.7b in the last year, which was a lot more than its statutory profit of CN¥709.4m. Wangfujing Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.
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 Wangfujing Group's Profit Performance
As we discussed above, Wangfujing 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 Wangfujing Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Better yet, its EPS are growing strongly, which is nice to see. 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. So while earnings quality is important, it's equally important to consider the risks facing Wangfujing Group at this point in time. You'd be interested to know, that we found 1 warning sign for Wangfujing Group and you'll want to know about it.
Today we've zoomed in on a single data point to better understand the nature of Wangfujing Group's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.