We Like The Quality Of Sumec's (SHSE:600710) Earnings

Sumec Corporation Limited's (SHSE:600710) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

Check out our latest analysis for Sumec

Examining Cashflow Against Sumec'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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 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 December 2023, Sumec recorded an accrual ratio of -0.33. 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¥2.4b, well over the CN¥1.03b it reported in profit. Sumec's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. 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.

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.

The Impact Of Unusual Items On Profit

Surprisingly, given Sumec's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥400m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Sumec 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 Sumec's Profit Performance

Sumec'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. Considering all the aforementioned, we'd venture that Sumec's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about Sumec as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Sumec, and understanding it should be part of your investment process.

Our examination of Sumec has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.