SmarTone Telecommunications Holdings’ (HKG:315) Conservative Accounting Might Explain Soft Earnings

Soft earnings didn’t appear to concern SmarTone Telecommunications Holdings Limited’s (HKG:315) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for SmarTone Telecommunications Holdings

Examining Cashflow Against SmarTone Telecommunications Holdings’ 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. The ratio shows us how much a company’s profit exceeds its FCF.

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. 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. 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, SmarTone Telecommunications Holdings had an accrual ratio of -0.18. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$953m in the last year, which was a lot more than its statutory profit of HK$258.8m. SmarTone Telecommunications Holdings’ 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 SmarTone Telecommunications Holdings’ Profit Performance

Happily for shareholders, SmarTone Telecommunications Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think SmarTone Telecommunications Holdings’ underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. 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. Case in point: We’ve spotted 3 warning signs for SmarTone Telecommunications Holdings you should be mindful of and 1 of them can’t be ignored.

This note has only looked at a single factor that sheds light on the nature of SmarTone Telecommunications Holdings’ 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. 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.