There Are Some Holes In Anhui Jianghuai Automobile GroupLtd's (SHSE:600418) Solid Earnings Release

Following the release of a positive earnings report recently, Anhui Jianghuai Automobile Group Corp.,Ltd.'s (SHSE:600418) stock performed well. However, we think that investors should be cautious when interpreting the profit numbers.

See our latest analysis for Anhui Jianghuai Automobile GroupLtd

Zooming In On Anhui Jianghuai Automobile GroupLtd'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. The ratio shows us how much a company's profit exceeds its FCF.

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".

For the year to September 2024, Anhui Jianghuai Automobile GroupLtd had an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥592.7m, a look at free cash flow indicates it actually burnt through CN¥977m in the last year. We saw that FCF was CN¥2.8b a year ago though, so Anhui Jianghuai Automobile GroupLtd has at least been able to generate positive FCF in the past. 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. The good news for shareholders is that Anhui Jianghuai Automobile GroupLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Anhui Jianghuai Automobile GroupLtd's profit was boosted by unusual items worth CN¥2.1b 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. 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. We can see that Anhui Jianghuai Automobile GroupLtd's positive unusual items were quite significant relative to its profit in the year to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Anhui Jianghuai Automobile GroupLtd's Profit Performance

Summing up, Anhui Jianghuai Automobile GroupLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Anhui Jianghuai Automobile GroupLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Anhui Jianghuai Automobile GroupLtd as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 1 warning sign for Anhui Jianghuai Automobile GroupLtd and we think they deserve your attention.

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 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. 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 with significant insider holdings 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.