Impressive Earnings May Not Tell The Whole Story For Shenzhen Soling IndustrialLtd (SZSE:002766)

Despite announcing strong earnings, Shenzhen Soling Industrial Co.,Ltd's (SZSE:002766) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

Zooming In On Shenzhen Soling IndustrialLtd'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. 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. 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 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".

Shenzhen Soling IndustrialLtd has an accrual ratio of 0.46 for the year to December 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥56m despite its profit of CN¥60.1m, mentioned above. We saw that FCF was CN¥145m a year ago though, so Shenzhen Soling IndustrialLtd has at least been able to generate positive FCF in the past. One positive for Shenzhen Soling IndustrialLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Soling IndustrialLtd.

Our Take On Shenzhen Soling IndustrialLtd's Profit Performance

As we have made quite clear, we're a bit worried that Shenzhen Soling IndustrialLtd didn't back up the last year's profit with free cashflow. For this reason, we think that Shenzhen Soling IndustrialLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Shenzhen Soling IndustrialLtd.

Today we've zoomed in on a single data point to better understand the nature of Shenzhen Soling IndustrialLtd'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. 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.