Guizhou Space Appliance Co., LTD (SZSE:002025) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.
Examining Cashflow Against Guizhou Space Appliance'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to December 2023, Guizhou Space Appliance had an accrual ratio of -0.10. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of CN¥1.2b in the last year, which was a lot more than its statutory profit of CN¥750.5m. Given that Guizhou Space Appliance had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥1.2b would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
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.
The Impact Of Unusual Items On Profit
Surprisingly, given Guizhou Space Appliance's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥86m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Guizhou Space Appliance doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.
Our Take On Guizhou Space Appliance's Profit Performance
Guizhou Space Appliance's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if Guizhou Space Appliance's profits are a reasonable reflection of its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. You'd be interested to know, that we found 1 warning sign for Guizhou Space Appliance and you'll want to know about it.
In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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.