The market was not impressed by the weak profits of Newlink Technology Inc. (HKG:9600) recently. Our analysis found a few reasons to worry, beyond the weak headline numbers.
Discover our latest analysis for Newlink Technology
Focus on the benefits of Newlink Technology
A key financial ratio used to measure a company’s ability to convert earnings into free cash flow (FCF) is the exercise ratio. To get the strike ratio, we first subtract FCF from earnings for a period and then divide that number by the average operating assets for the period. You can think of the cash flow equalization ratio as the “non-FCF profit ratio”.
This means that a negative accrual ratio is a good thing because it shows that the company is generating more free cash flow than its earnings suggest. While it’s fine to have a positive accrual ratio, indicating some level of non-monetary benefits, a high accrual ratio is arguably a bad thing, as it indicates that the earnings on paper do not match the cash flow. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accrued liabilities tend to be less profitable in the future.”
For the year to December 2021, Newlink Technology had a accrual ratio of 0.70. Statistically speaking, this is a real negative for future profits. Namely, the company did not generate a single penny of free cash flow during this period. Although it reported a profit of 13.0 million Canadian yen, an examination of free cash flow indicates that it has actually burned 147 million Canadian yen over the past year. We saw that the FCF was CN¥5.4 million a year ago, so Newlink Technology has at least been able to generate positive FCF in the past.
To note: we always recommend that investors check the strength of the balance sheet. Click here to access our analysis of Newlink Technology’s balance sheet.
Our view on Newlink Technology’s earnings performance
As we’ve made very clear, we’re a bit concerned that Newlink Technology didn’t support last year’s earnings with free cash flow. For this reason, we believe that Newlink Technology’s statutory earnings may be a poor indicator of its underlying earning power and could give investors an overly positive impression of the company. In other bad news, its earnings per share have declined over the past year. The aim of this article has been to assess how much we can rely on statutory income to reflect business potential, but there is much more to consider. With this in mind, we would not consider investing in a stock unless we have a thorough understanding of the risks. To help you, we found 3 warning signs (1 doesn’t sit well with us!) that you should be aware of before buying shares of Newlink Technology.
This note has considered only one factor that sheds light on the nature of Newlink Technology’s earnings. But there’s always more to discover if you’re able to focus on the details. Some people consider a high return on equity to be a good sign of a quality company. Although it might take a bit of research on your behalf, you might find this free collection of companies offering a high return on equity, or this list of stocks that insiders buy to be useful.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.