The subdued stock price reaction suggests that Dong-E-E-Jiao Co.,Ltd.'s (SZSE:000423) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.
A Closer Look At Dong-E-E-JiaoLtd'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.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2023, Dong-E-E-JiaoLtd recorded an accrual ratio of -0.27. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥1.9b in the last year, which was a lot more than its statutory profit of CN¥1.15b. Dong-E-E-JiaoLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.
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 Dong-E-E-JiaoLtd's Profit Performance
As we discussed above, Dong-E-E-JiaoLtd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Dong-E-E-JiaoLtd's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Dong-E-E-JiaoLtd at this point in time. While conducting our analysis, we found that Dong-E-E-JiaoLtd has 1 warning sign and it would be unwise to ignore this.
Today we've zoomed in on a single data point to better understand the nature of Dong-E-E-JiaoLtd'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.