Following the release of a lackluster earnings report from Guanghe Landscape Culture Communication Co., Ltd. (SHSE:600234) the stock price made a strong positive move. We looked at the details, and we think that investors may be responding to some encouraging factors.

View our latest analysis for Guanghe Landscape Culture Communication

A Closer Look At Guanghe Landscape Culture Communication'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".

Guanghe Landscape Culture Communication has an accrual ratio of 0.33 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. Even though it reported a profit of CN¥12.6m, a look at free cash flow indicates it actually burnt through CN¥132m in the last year. It's worth noting that Guanghe Landscape Culture Communication generated positive FCF of CN¥27m a year ago, so at least they've done it in the past. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guanghe Landscape Culture Communication.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Guanghe Landscape Culture Communication expanded the number of shares on issue by 30% over the last year. Therefore, each share now receives a smaller portion of profit. 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 Guanghe Landscape Culture Communication's historical EPS growth by clicking on this link.

A Look At The Impact Of Guanghe Landscape Culture Communication's Dilution on Its Earnings Per Share (EPS).

Three years ago, Guanghe Landscape Culture Communication lost money. Even looking at the last year, profit was still down 78%. Sadly, earnings per share fell further, down a full 80% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.

If Guanghe Landscape Culture Communication's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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.

The Impact Of Unusual Items On Profit

Guanghe Landscape Culture Communication's profit suffered from unusual items, which reduced profit by CN¥6.4m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Guanghe Landscape Culture Communication doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Guanghe Landscape Culture Communication's Profit Performance

Summing up, Guanghe Landscape Culture Communication's unusual items suggest that its statutory earnings were temporarily depressed, and its accrual ratio indicates a lack of free cash flow relative to profit. And the dilution means that per-share results are weaker than the bottom line might imply. Based on these factors, we think that Guanghe Landscape Culture Communication's statutory profits probably make it seem better than it is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 4 warning signs for Guanghe Landscape Culture Communication you should be mindful of and 1 of these makes us a bit uncomfortable.

Our examination of Guanghe Landscape Culture Communication 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 is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.