The market for A8 New Media Group Limited's (HKG:800) stock was strong after it released a healthy earnings report last week. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.
Operating Revenue Or Not?
Most companies divide classify their revenue as either 'operating revenue', which comes from normal operations, and other revenue, which could include government grants, for example. Oftentimes, non-operating revenue spikes are not repeated, so it makes sense to be cautious where non-operating revenue has made a very large contribution to total profit. Importantly, the non-operating revenue often comes without associated ongoing costs, so it can boost profit by letting it fall straight to the bottom line, making the operating business seem better than it really is. It's worth noting that A8 New Media Group saw a big increase in non-operating revenue over the last year. In fact, our data indicates that non-operating revenue increased from CN¥5.80m to CN¥9.94m. The high levels of non-operating revenue are problematic because if (and when) they do not repeat, then overall revenue (and profitability) of the firm will fall. In order to better understand a company's profit result, it can sometimes help to consider whether the result would be very different without a sudden increase in non-operating revenue.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of A8 New Media Group.
How Do Unusual Items Influence Profit?
Alongside that spike in non-operating revenue, it's also important to note that A8 New Media Group'sprofit suffered from unusual items, which reduced profit by CN¥52m in the last twelve months. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. A8 New Media Group 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.
An Unusual Tax Situation
On top of the spike and non-operating revenue and the unusual item, we can also see that A8 New Media Group received a tax benefit of CN¥5.4m. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! Of course, prima facie it's great to receive a tax benefit. 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 A8 New Media Group's Profit Performance
In the last year A8 New Media Group's non-operating revenue really gave it a boost, but not in a way that is necessarily going to be sustained. And on top of that, its profit was boosted by a tax benefit! In contrast, it also booked a charge to unusual items, which suppressed its profit. Having considered these factors, we don't think A8 New Media Group's statutory profits give an overly harsh view of the business. So while earnings quality is important, it's equally important to consider the risks facing A8 New Media Group at this point in time. Every company has risks, and we've spotted 3 warning signs for A8 New Media Group you should know about.
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. Some people consider a high return on equity to be a good sign of a quality business. 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.