Earnings Troubles May Signal Larger Issues for Chongqing Sulian PlasticLtd (SZSE:301397) Shareholders

The subdued market reaction suggests that Chongqing Sulian Plastic Co.,Ltd.'s (SZSE:301397) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Chongqing Sulian PlasticLtd

Zooming In On Chongqing Sulian PlasticLtd'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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Chongqing Sulian PlasticLtd recorded an accrual ratio of 0.20. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥148.5m, a look at free cash flow indicates it actually burnt through CN¥57m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥57m, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chongqing Sulian PlasticLtd.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Chongqing Sulian PlasticLtd's profit was boosted by unusual items worth CN¥18m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Chongqing Sulian PlasticLtd 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 Chongqing Sulian PlasticLtd's Profit Performance

Summing up, Chongqing Sulian PlasticLtd 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 Chongqing Sulian PlasticLtd's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 2 warning signs for Chongqing Sulian PlasticLtd (1 is significant) you should be familiar with.

Our examination of Chongqing Sulian PlasticLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.