Zibo Qixiang Tengda Chemical Co., Ltd's (SZSE:002408) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Zibo Qixiang Tengda Chemical

Examining Cashflow Against Zibo Qixiang Tengda Chemical'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2022, Zibo Qixiang Tengda Chemical had an accrual ratio of 0.37. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥3.9b despite its profit of CN¥2.28b, mentioned above. We also note that Zibo Qixiang Tengda Chemical's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥3.9b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zibo Qixiang Tengda Chemical.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Zibo Qixiang Tengda Chemical expanded the number of shares on issue by 7.0% over the last year. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Zibo Qixiang Tengda Chemical's EPS by clicking here.

How Is Dilution Impacting Zibo Qixiang Tengda Chemical's Earnings Per Share? (EPS)

Zibo Qixiang Tengda Chemical has improved its profit over the last three years, with an annualized gain of 192% in that time. In comparison, earnings per share only gained 156% over the same period. And at a glance the 58% gain in profit over the last year impresses. But in comparison, EPS only increased by 35% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Zibo Qixiang Tengda Chemical can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Zibo Qixiang Tengda Chemical's Profit Performance

In conclusion, Zibo Qixiang Tengda Chemical has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. Considering all this we'd argue Zibo Qixiang Tengda Chemical's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Zibo Qixiang Tengda Chemical, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 3 warning signs for Zibo Qixiang Tengda Chemical (of which 1 doesn't sit too well with us!) 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. 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 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.