As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Shaanxi Northwest New Technology Industry (HKG:8258).
We like the fact that Shaanxi Northwest New Technology Industry made a profit of CN¥9.35m on its revenue of CN¥30.5m, in the last year. The chart below shows that revenue has been pretty flat over the last three years, but profit has increased.
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we’ll look at what Shaanxi Northwest New Technology Industry’s cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shaanxi Northwest New Technology Industry.
Zooming In On Shaanxi Northwest New Technology Industry’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. This ratio tells us how much of a company’s profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Shaanxi Northwest New Technology Industry has an accrual ratio of 0.27 for the year to June 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥20.2m, in contrast to the aforementioned profit of CN¥9.35m. It’s worth noting that Shaanxi Northwest New Technology Industry generated positive FCF of CN¥8.7m a year ago, so at least they’ve done it in the past.
Our Take On Shaanxi Northwest New Technology Industry’s Profit Performance
Shaanxi Northwest New Technology Industry didn’t convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Shaanxi Northwest New Technology Industry’s true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. At the end of the day, it’s essential to consider more than just the factors above, if you want to understand the company properly. 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. Case in point: We’ve spotted 4 warning signs for Shaanxi Northwest New Technology Industry you should be mindful of and 1 of them makes us a bit uncomfortable.
Today we’ve zoomed in on a single data point to better understand the nature of Shaanxi Northwest New Technology Industry’s profit. 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. 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. 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.
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