The Strong Earnings Posted By Xiamen King Long Motor Group (SHSE:600686) Are A Good Indication Of The Strength Of The Business

Even though Xiamen King Long Motor Group Co., Ltd. (SHSE:600686 ) posted strong earnings, investors appeared to be underwhelmed. Our analysis says that investors should be optimistic, as the strong profit is built on solid foundations.

View our latest analysis for Xiamen King Long Motor Group

A Closer Look At Xiamen King Long Motor Group's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Xiamen King Long Motor Group has an accrual ratio of -0.92 for the year to March 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥2.3b, well over the CN¥82.1m it reported in profit. Notably, Xiamen King Long Motor Group had negative free cash flow last year, so the CN¥2.3b it produced this year was a welcome improvement. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Xiamen King Long Motor Group.

How Do Unusual Items Influence Profit?

Xiamen King Long Motor Group's profit was reduced by unusual items worth CN¥64m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. In the twelve months to March 2024, Xiamen King Long Motor Group had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Xiamen King Long Motor Group's Profit Performance

Considering both Xiamen King Long Motor Group's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Xiamen King Long Motor Group's statutory profit probably understates its earnings potential! So while earnings quality is important, it's equally important to consider the risks facing Xiamen King Long Motor Group at this point in time. When we did our research, we found 2 warning signs for Xiamen King Long Motor Group (1 is a bit unpleasant!) that we believe deserve your full attention.

After our examination into the nature of Xiamen King Long Motor Group's profit, we've come away optimistic for the company. 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. 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.