A lackluster earnings announcement from Shenyang Fortune Precision Equipment Co., Ltd. (SHSE:688409) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.
A Closer Look At Shenyang Fortune Precision Equipment'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. The ratio shows us how much a company's profit exceeds its FCF.
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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to March 2024, Shenyang Fortune Precision Equipment had an accrual ratio of 0.54. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥189.7m, a look at free cash flow indicates it actually burnt through CN¥1.7b in the last year. We also note that Shenyang Fortune Precision Equipment's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.7b.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
Our Take On Shenyang Fortune Precision Equipment's Profit Performance
As we have made quite clear, we're a bit worried that Shenyang Fortune Precision Equipment didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Shenyang Fortune Precision Equipment's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 32% per annum growth in EPS for the last three. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Shenyang Fortune Precision Equipment has 3 warning signs (1 is concerning!) that deserve your attention before going any further with your analysis.
Today we've zoomed in on a single data point to better understand the nature of Shenyang Fortune Precision Equipment's profit. 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.