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Micro-Mechanics (Holdings) Ltd.'s (SGX:5DD) solid earnings announcement recently didn't do much to the stock price. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.
See our latest analysis for Micro-Mechanics (Holdings)
Examining Cashflow Against Micro-Mechanics (Holdings)'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".
Micro-Mechanics (Holdings) has an accrual ratio of -0.13 for the year to September 2024. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of S$12m during the period, dwarfing its reported profit of S$8.42m. Micro-Mechanics (Holdings)'s free cash flow improved over the last year, which is generally good to see.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Micro-Mechanics (Holdings).
Our Take On Micro-Mechanics (Holdings)'s Profit Performance
Micro-Mechanics (Holdings)'s accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Micro-Mechanics (Holdings)'s statutory profit actually understates its earnings potential! 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. If you'd like to know more about Micro-Mechanics (Holdings) as a business, it's important to be aware of any risks it's facing. Be aware that Micro-Mechanics (Holdings) is showing 2 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...