We Think You Can Look Beyond YAPP Automotive Systems' (SHSE:603013) Lackluster Earnings

The market for YAPP Automotive Systems Co., Ltd.'s (SHSE:603013) shares didn't move much after it posted weak earnings recently. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

See our latest analysis for YAPP Automotive Systems

Zooming In On YAPP Automotive Systems' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

YAPP Automotive Systems has an accrual ratio of -0.12 for the year to September 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of CN¥704m in the last year, which was a lot more than its statutory profit of CN¥431.9m. YAPP Automotive Systems' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of YAPP Automotive Systems.

How Do Unusual Items Influence Profit?

YAPP Automotive Systems' profit was reduced by unusual items worth CN¥78m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect YAPP Automotive Systems to produce a higher profit next year, all else being equal.

Our Take On YAPP Automotive Systems' Profit Performance

Considering both YAPP Automotive Systems' accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Looking at all these factors, we'd say that YAPP Automotive Systems' underlying earnings power is at least as good as the statutory numbers would make it seem. If you want to do dive deeper into YAPP Automotive Systems, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 1 warning sign for YAPP Automotive Systems you should know about.

Our examination of YAPP Automotive Systems has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 with high insider ownership.

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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.