Guangzhou Jinzhong Auto Parts Manufacturing's (SZSE:301133) Earnings Are Of Questionable Quality

Guangzhou Jinzhong Auto Parts Manufacturing Co., Ltd. (SZSE:301133) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Check out our latest analysis for Guangzhou Jinzhong Auto Parts Manufacturing

A Closer Look At Guangzhou Jinzhong Auto Parts Manufacturing'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

Guangzhou Jinzhong Auto Parts Manufacturing has an accrual ratio of 0.24 for the year to March 2024. 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¥100.3m, a look at free cash flow indicates it actually burnt through CN¥94m in the last year. We also note that Guangzhou Jinzhong Auto Parts Manufacturing's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥94m.

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.

Our Take On Guangzhou Jinzhong Auto Parts Manufacturing's Profit Performance

Guangzhou Jinzhong Auto Parts Manufacturing didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Guangzhou Jinzhong Auto Parts Manufacturing's statutory profits are better than its underlying earnings power. 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 while earnings quality is important, it's equally important to consider the risks facing Guangzhou Jinzhong Auto Parts Manufacturing at this point in time. For example, Guangzhou Jinzhong Auto Parts Manufacturing has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Guangzhou Jinzhong Auto Parts Manufacturing'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.