Xiamen King Long Motor Group's (SHSE:600686) Earnings Seem To Be Promising

Xiamen King Long Motor Group Co., Ltd. (SHSE:600686) just released a solid earnings report, and the stock displayed some strength. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

See our latest analysis for Xiamen King Long Motor Group

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

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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, Xiamen King Long Motor Group recorded an accrual ratio of -1.02. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥1.4b during the period, dwarfing its reported profit of CN¥94.8m. Xiamen King Long Motor Group did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. 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 Xiamen King Long Motor Group.

The Impact Of Unusual Items On Profit

Surprisingly, given Xiamen King Long Motor Group's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥371m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Xiamen King Long Motor Group had a rather significant contribution from unusual items relative to its profit to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

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

Xiamen King Long Motor Group's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Xiamen King Long Motor Group's profits are an apt reflection of its underlying potential for profit. If you want to do dive deeper into Xiamen King Long Motor Group, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 3 warning signs for Xiamen King Long Motor Group (of which 2 are significant!) you should know about.

Our examination of Xiamen King Long Motor Group has focussed on certain factors that can make its earnings look better than they are. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.