Solid Earnings Reflect Shanghai Material Trading's (SHSE:600822) Strength As A Business

Despite announcing strong earnings, Shanghai Material Trading Co., Ltd.'s (SHSE:600822) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

See our latest analysis for Shanghai Material Trading

A Closer Look At Shanghai Material Trading'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2023, Shanghai Material Trading recorded an accrual ratio of -0.35. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥272m, well over the CN¥140.0m it reported in profit. Given that Shanghai Material Trading had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥272m would seem to be a step in the right direction. However, that's not all there is to consider. 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 Shanghai Material Trading.

The Impact Of Unusual Items On Profit

Surprisingly, given Shanghai Material Trading's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥14m 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 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'. We can see that Shanghai Material Trading's positive unusual items were quite significant relative to its profit in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Shanghai Material Trading's Profit Performance

Shanghai Material Trading'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. Based on these factors, it's hard to tell if Shanghai Material Trading's profits are a reasonable reflection of its underlying profitability. While earnings are important, another area to consider is the balance sheet. If you're interested we have a graphic representation of Shanghai Material Trading's balance sheet.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 that insiders are buying.

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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.