Wecon Holdings Limited (HKG:1793) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. However, we think that shareholders may be missing some concerning details in the numbers.

Check out our latest analysis for Wecon Holdings

Zooming In On Wecon Holdings’ Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company’s free cash flow (FCF) matches its profit. 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.

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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Wecon Holdings recorded an accrual ratio of -0.68. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of HK$113m, well over the HK$8.86m it reported in profit. Wecon Holdings’ free cash flow improved over the last year, which is generally good to see. 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 Wecon Holdings.

How Do Unusual Items Influence Profit?

Surprisingly, given Wecon Holdings’ accrual ratio implied strong cash conversion, its paper profit was actually boosted by HK$2.6m in unusual items. We can’t deny that higher profits generally leave us optimistic, but we’d prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it’s very common for unusual items to be once-off in nature. And, after all, that’s exactly what the accounting terminology implies. Wecon Holdings had a rather significant contribution from unusual items relative to its profit to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Wecon Holdings’ Profit Performance

Wecon Holdings’ profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it’s hard to tell if Wecon Holdings’ profits are a reasonable reflection of its underlying profitability. If you’d like to know more about Wecon Holdings as a business, it’s important to be aware of any risks it’s facing. Every company has risks, and we’ve spotted 4 warning signs for Wecon Holdings (of which 1 is a bit unpleasant!) you should know about.

In this article we’ve looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 with significant insider holdings 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.