Shanghai YanPu Metal Products Co.,Ltd's (SHSE:605128) recent weak earnings report didn't cause a big stock movement. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

See our latest analysis for Shanghai YanPu Metal ProductsLtd

Zooming In On Shanghai YanPu Metal ProductsLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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".

Shanghai YanPu Metal ProductsLtd has an accrual ratio of 0.23 for the year to December 2021. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥70.5m, a look at free cash flow indicates it actually burnt through CN¥81m in the last year. We also note that Shanghai YanPu Metal ProductsLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥81m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanghai YanPu Metal ProductsLtd.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥12m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Shanghai YanPu Metal ProductsLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Shanghai YanPu Metal ProductsLtd's Profit Performance

Shanghai YanPu Metal ProductsLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Shanghai YanPu Metal ProductsLtd's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Shanghai YanPu Metal ProductsLtd as a business, it's important to be aware of any risks it's facing. For example, Shanghai YanPu Metal ProductsLtd has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.