Jiangsu Linyang Energy's (SHSE:601222) Profits Appear To Have Quality Issues

Following the solid earnings report from Jiangsu Linyang Energy Co., Ltd. (SHSE:601222), the market responded by bidding up the stock price. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

View our latest analysis for Jiangsu Linyang Energy

Examining Cashflow Against Jiangsu Linyang Energy'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

For the year to March 2024, Jiangsu Linyang Energy had an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥1.7b despite its profit of CN¥1.05b, mentioned above. It's worth noting that Jiangsu Linyang Energy generated positive FCF of CN¥55m a year ago, so at least they've done it in the past.

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.

Our Take On Jiangsu Linyang Energy's Profit Performance

Jiangsu Linyang Energy's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Jiangsu Linyang Energy's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 5.7% EPS growth in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Jiangsu Linyang Energy as a business, it's important to be aware of any risks it's facing. When we did our research, we found 2 warning signs for Jiangsu Linyang Energy (1 is significant!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Jiangsu Linyang Energy's profit. But there are plenty of other ways to inform your opinion of a company. 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.