We didn't see NAURA Technology Group Co., Ltd.'s (SZSE:002371) stock surge when it reported robust earnings recently. We think that investors might be worried about the foundations the earnings are built on.

View our latest analysis for NAURA Technology Group

Zooming In On NAURA Technology Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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".

Over the twelve months to March 2022, NAURA Technology Group recorded an accrual ratio of 0.60. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥3.4b, in contrast to the aforementioned profit of CN¥1.21b. It's worth noting that NAURA Technology Group generated positive FCF of CN¥812m a year ago, so at least they've done it in the past. However, that's not the end of the story. 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. One positive for NAURA Technology Group shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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, NAURA Technology Group increased the number of shares on issue by 6.2% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of NAURA Technology Group's EPS by clicking here.

A Look At The Impact Of NAURA Technology Group's Dilution on Its Earnings Per Share (EPS).

As you can see above, NAURA Technology Group has been growing its net income over the last few years, with an annualized gain of 408% over three years. But EPS was only up 357% per year, in the exact same period. And at a glance the 108% gain in profit over the last year impresses. But in comparison, EPS only increased by 101% over the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if NAURA Technology Group 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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that NAURA Technology Group's profit was boosted by unusual items worth CN¥325m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. We can see that NAURA Technology Group's positive unusual items were quite significant relative to its profit in the year to March 2022. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On NAURA Technology Group's Profit Performance

NAURA Technology Group didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. On reflection, the above-mentioned factors give us the strong impression that NAURA Technology Group'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you'd like to know more about NAURA Technology Group as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for NAURA Technology Group (1 makes us a bit uncomfortable!) and we strongly recommend you look at these before investing.

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. 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.