Shaanxi Huaqin Technology Industry Co.,Ltd.'s (SHSE:688281) stock performed strongly after the recent earnings report. However, we think that investors should be cautious when interpreting the profit numbers.

A Closer Look At Shaanxi Huaqin Technology IndustryLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 March 2024, Shaanxi Huaqin Technology IndustryLtd recorded an accrual ratio of 0.68. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥690m despite its profit of CN¥361.0m, mentioned above. We also note that Shaanxi Huaqin Technology IndustryLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥690m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

Given the accrual ratio, it's not overly surprising that Shaanxi Huaqin Technology IndustryLtd's profit was boosted by unusual items worth CN¥23m 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Shaanxi Huaqin Technology IndustryLtd 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 Shaanxi Huaqin Technology IndustryLtd's Profit Performance

Shaanxi Huaqin Technology IndustryLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shaanxi Huaqin Technology IndustryLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Shaanxi Huaqin Technology IndustryLtd, you'd also look into what risks it is currently facing. For example - Shaanxi Huaqin Technology IndustryLtd has 1 warning sign we think you should be aware of.

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. Some people consider a high return on equity to be a good sign of a quality business. 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.