The market seemed underwhelmed by last week's earnings announcement from Hangzhou Zhongheng Electric Co., Ltd (SZSE:002364) despite the healthy numbers. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

The Impact Of Unusual Items On Profit

To properly understand Hangzhou Zhongheng Electric's profit results, we need to consider the CN¥31m expense attributed to unusual items. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. 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. Hangzhou Zhongheng Electric took a rather significant hit from unusual items in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hangzhou Zhongheng Electric.

An Unusual Tax Situation

Having already discussed the impact of the unusual items, we should also note that Hangzhou Zhongheng Electric received a tax benefit of CN¥17m. This is meaningful because companies usually pay tax rather than receive tax benefits. The receipt of a tax benefit is obviously a good thing, on its own. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Hangzhou Zhongheng Electric's Profit Performance

In its last report Hangzhou Zhongheng Electric received a tax benefit which might make its profit look better than it really is on a underlying level. But on the other hand, it also saw an unusual item depress its profit. Considering all the aforementioned, we'd venture that Hangzhou Zhongheng Electric's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To help with this, we've discovered 2 warning signs (1 is significant!) that you ought to be aware of before buying any shares in Hangzhou Zhongheng Electric.

Our examination of Hangzhou Zhongheng Electric has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.