Investors signalled that they were pleased with Harbin Hatou Investment Co.,Ltd's (SHSE:600864) most recent earnings report. Looking deeper at the numbers, we found several encouraging factors beyond the headline profit numbers.
Zooming In On Harbin Hatou InvestmentLtd'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). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Harbin Hatou InvestmentLtd has an accrual ratio of -0.42 for the year to March 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of CN¥3.2b in the last year, which was a lot more than its statutory profit of CN¥156.1m. Harbin Hatou InvestmentLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Harbin Hatou InvestmentLtd.
The Impact Of Unusual Items On Profit
Harbin Hatou InvestmentLtd's profit was reduced by unusual items worth CN¥176m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. In the twelve months to March 2024, Harbin Hatou InvestmentLtd had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.
Our Take On Harbin Hatou InvestmentLtd's Profit Performance
In conclusion, both Harbin Hatou InvestmentLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Harbin Hatou InvestmentLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you'd like to know more about Harbin Hatou InvestmentLtd as a business, it's important to be aware of any risks it's facing. For example, Harbin Hatou InvestmentLtd has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
After our examination into the nature of Harbin Hatou InvestmentLtd's profit, we've come away optimistic for the company. 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.