Kangqiao Service Group's (HKG:2205) Promising Earnings May Rest On Soft Foundations

Kangqiao Service Group Limited's (HKG:2205) stock was strong after they recently reported robust earnings. However, we think that shareholders may be missing some concerning details in the numbers.

Zooming In On Kangqiao Service Group's 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Kangqiao Service Group has an accrual ratio of 0.54 for the year to December 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥48.4m, a look at free cash flow indicates it actually burnt through CN¥208m in the last year. We also note that Kangqiao Service Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥208m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kangqiao Service Group.

Our Take On Kangqiao Service Group's Profit Performance

As we have made quite clear, we're a bit worried that Kangqiao Service Group didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Kangqiao Service Group's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 26% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Kangqiao Service Group as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 3 warning signs (2 are significant!) that you ought to be aware of before buying any shares in Kangqiao Service Group.

This note has only looked at a single factor that sheds light on the nature of Kangqiao Service Group's 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 with high insider ownership.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.