Jiangsu General Science Technology's (SHSE:601500) Earnings Are Weaker Than They Seem

Despite announcing strong earnings, Jiangsu General Science Technology Co., Ltd.'s (SHSE:601500) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for Jiangsu General Science Technology

A Closer Look At Jiangsu General Science Technology's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2024, Jiangsu General Science Technology had an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥1.6b, in contrast to the aforementioned profit of CN¥437.6m. We also note that Jiangsu General Science Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.6b. 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

The fact that the company had unusual items boosting profit by CN¥52m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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 Jiangsu General Science Technology 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 Jiangsu General Science Technology's Profit Performance

Summing up, Jiangsu General Science Technology 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 Jiangsu General Science Technology's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Jiangsu General Science Technology at this point in time. For example, Jiangsu General Science Technology has 3 warning signs (and 2 which are a bit concerning) we think you should know about.

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.