Shareholders didn't seem to be thrilled with CETC Acoustic-Optic-Electronic Technology Inc.'s (SHSE:600877) recent earnings report, despite healthy profit numbers. Our analysis suggests they may be concerned about some underlying details.

See our latest analysis for CETC Acoustic-Optic-Electronic Technology

Zooming In On CETC Acoustic-Optic-Electronic Technology'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. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

CETC Acoustic-Optic-Electronic Technology has an accrual ratio of 0.30 for the year to December 2021. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥70m despite its profit of CN¥139.0m, mentioned above. It's worth noting that CETC Acoustic-Optic-Electronic Technology generated positive FCF of CN¥62m a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, CETC Acoustic-Optic-Electronic Technology increased the number of shares on issue by 44% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out CETC Acoustic-Optic-Electronic Technology's historical EPS growth by clicking on this link.

How Is Dilution Impacting CETC Acoustic-Optic-Electronic Technology's Earnings Per Share? (EPS)

As you can see above, CETC Acoustic-Optic-Electronic Technology has been growing its net income over the last few years, with an annualized gain of 115% over three years. In contrast, earnings per share were actually down by 29% per year, in the exact same period. And at a glance the 73% gain in profit over the last year impresses. On the other hand, earnings per share are only up 60% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So CETC Acoustic-Optic-Electronic Technology shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On CETC Acoustic-Optic-Electronic Technology's Profit Performance

In conclusion, CETC Acoustic-Optic-Electronic Technology 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 CETC Acoustic-Optic-Electronic Technology's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about CETC Acoustic-Optic-Electronic Technology as a business, it's important to be aware of any risks it's facing. For example, we've found that CETC Acoustic-Optic-Electronic Technology has 4 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

Our examination of CETC Acoustic-Optic-Electronic Technology has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.