Central New Energy Holding Group's (HKG:1735) Earnings Aren't As Good As They Appear

Central New Energy Holding Group Limited (HKG:1735) recently released a strong earnings report, and the market responded by raising the share price. However, we think that shareholders should be aware of some other factors beyond the profit numbers.

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A Closer Look At Central New Energy Holding Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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".

Central New Energy Holding Group has an accrual ratio of 0.44 for the year to December 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of HK$1.1b, in contrast to the aforementioned profit of HK$106.4m. We also note that Central New Energy Holding Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$1.1b. 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.

See our latest analysis for Central New Energy Holding Group

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Central New Energy Holding Group.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by HK$42m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Central New Energy Holding Group had a rather significant contribution from unusual items relative to its profit to December 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Central New Energy Holding Group's Profit Performance

Central New Energy Holding Group had a weak accrual ratio, but its profit did receive a boost from unusual items. On reflection, the above-mentioned factors give us the strong impression that Central New Energy Holding Group'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. You'd be interested to know, that we found 2 warning signs for Central New Energy Holding Group and you'll want to know about these bad boys.

Our examination of Central New Energy Holding Group has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 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.