Ningbo Gaofa Automotive Control System's (SHSE:603788) Earnings Are Weaker Than They Seem

Ningbo Gaofa Automotive Control System Co., Ltd.'s (SHSE:603788) stock was strong after they recently reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for Ningbo Gaofa Automotive Control System

Examining Cashflow Against Ningbo Gaofa Automotive Control System'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Ningbo Gaofa Automotive Control System has an accrual ratio of 0.20 for the year to December 2023. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥39m despite its profit of CN¥162.6m, mentioned above. We also note that Ningbo Gaofa Automotive Control System's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥39m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ningbo Gaofa Automotive Control System.

Our Take On Ningbo Gaofa Automotive Control System's Profit Performance

Ningbo Gaofa Automotive Control System's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Ningbo Gaofa Automotive Control System's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 42% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, Ningbo Gaofa Automotive Control System has 3 warning signs (and 2 which don't sit too well with us) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Ningbo Gaofa Automotive Control System's profit. 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. 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. 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.