A lackluster earnings announcement from Mewah International Inc. (SGX:MV4) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

A Closer Look At Mewah International'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. 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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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".

Over the twelve months to December 2024, Mewah International recorded an accrual ratio of 0.24. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of US$38.8m, a look at free cash flow indicates it actually burnt through US$241m in the last year. We saw that FCF was US$176m a year ago though, so Mewah International has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for Mewah International shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mewah International.

The Impact Of Unusual Items On Profit

Mewah International's profit suffered from unusual items, which reduced profit by US$16m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Mewah International doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Mewah International's Profit Performance

Mewah International saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Given the contrasting considerations, we don't have a strong view as to whether Mewah International's profits are an apt reflection of its underlying potential for profit. So while earnings quality is important, it's equally important to consider the risks facing Mewah International at this point in time. For example - Mewah International has 2 warning signs we think you should be aware of.

Our examination of Mewah International has focussed on certain factors that can make its earnings look better than they are. 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 with high insider ownership.

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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.