Shanghai Tongji Science&Technology IndustrialLtd's (SHSE:600846) Weak Earnings Might Be Worse Than They Appear

Shanghai Tongji Science&Technology Industrial Co.,Ltd's (SHSE:600846) stock wasn't much affected by its recent lackluster earnings numbers. Our analysis suggests that they may be missing some concerning details underlying the profit numbers.

View our latest analysis for Shanghai Tongji Science&Technology IndustrialLtd

Examining Cashflow Against Shanghai Tongji Science&Technology IndustrialLtd'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). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 September 2024, Shanghai Tongji Science&Technology IndustrialLtd recorded an accrual ratio of 0.41. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥404.6m, a look at free cash flow indicates it actually burnt through CN¥984m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥984m, this year, indicates high risk. 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 Tongji Science&Technology IndustrialLtd.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥17m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Shanghai Tongji Science&Technology IndustrialLtd 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 Shanghai Tongji Science&Technology IndustrialLtd's Profit Performance

Shanghai Tongji Science&Technology IndustrialLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shanghai Tongji Science&Technology IndustrialLtd's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with Shanghai Tongji Science&Technology IndustrialLtd (including 2 which can't be ignored).

Our examination of Shanghai Tongji Science&Technology IndustrialLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with significant insider holdings 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.