Solid Earnings May Not Tell The Whole Story For Wuhan East Lake High Technology Group (SHSE:600133)

Wuhan East Lake High Technology Group Co., Ltd.'s (SHSE:600133) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for Wuhan East Lake High Technology Group

Examining Cashflow Against Wuhan East Lake High Technology Group'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. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, Wuhan East Lake High Technology Group recorded an accrual ratio of 0.22. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥2.2b despite its profit of CN¥1.05b, mentioned above. It's worth noting that Wuhan East Lake High Technology Group generated positive FCF of CN¥607m a year ago, so at least they've done it in the past. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wuhan East Lake High Technology Group.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Wuhan East Lake High Technology Group increased the number of shares on issue by 34% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Wuhan East Lake High Technology Group's historical EPS growth by clicking on this link.

How Is Dilution Impacting Wuhan East Lake High Technology Group's Earnings Per Share (EPS)?

Wuhan East Lake High Technology Group has improved its profit over the last three years, with an annualized gain of 37% in that time. But EPS was only up 15% per year, in the exact same period. And the 72% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 52% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Wuhan East Lake High Technology Group shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Wuhan East Lake High Technology Group's profit suffered from unusual items, which reduced profit by CN¥169m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. 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 that's hardly a surprise given these line items are considered unusual. If Wuhan East Lake High Technology Group doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Wuhan East Lake High Technology Group's Profit Performance

In conclusion, Wuhan East Lake High Technology Group's accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. On top of that, the dilution means that shareholders now own less of the company. After taking into account all the aforementioned observations we think that Wuhan East Lake High Technology Group's profits probably give a generous impression of its sustainable level of profitability. If you want to do dive deeper into Wuhan East Lake High Technology Group, you'd also look into what risks it is currently facing. For example, we've found that Wuhan East Lake High Technology Group has 3 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 that insiders are buying 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.