Shareholders were pleased with the recent earnings report from Circuit Fabology Microelectronics Equipment Co.,Ltd. (SHSE:688630). However, we think that investors should be cautious when interpreting the profit numbers.

A Closer Look At Circuit Fabology Microelectronics EquipmentLtd'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Circuit Fabology Microelectronics EquipmentLtd has an accrual ratio of 0.32 for the year to March 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥122m, in contrast to the aforementioned profit of CN¥185.6m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥122m, this year, indicates high risk. 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.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Circuit Fabology Microelectronics EquipmentLtd issued 8.8% more new shares over the last year. 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. Check out Circuit Fabology Microelectronics EquipmentLtd's historical EPS growth by clicking on this link.

How Is Dilution Impacting Circuit Fabology Microelectronics EquipmentLtd's Earnings Per Share (EPS)?

Circuit Fabology Microelectronics EquipmentLtd has improved its profit over the last three years, with an annualized gain of 127% in that time. But EPS was only up 52% per year, in the exact same period. And the 23% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 15% in that time. 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 Circuit Fabology Microelectronics EquipmentLtd shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Circuit Fabology Microelectronics EquipmentLtd's profit was boosted by unusual items worth CN¥27m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Circuit Fabology Microelectronics EquipmentLtd's Profit Performance

Circuit Fabology Microelectronics EquipmentLtd didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. The dilution means the results are weaker when viewed from a per-share perspective. For all the reasons mentioned above, we think that, at a glance, Circuit Fabology Microelectronics EquipmentLtd's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Our analysis shows 3 warning signs for Circuit Fabology Microelectronics EquipmentLtd (1 doesn't sit too well with us!) and we strongly recommend you look at them 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.