Anhui Anfu Battery TechnologyLtd's (SHSE:603031) Promising Earnings May Rest On Soft Foundations

Unsurprisingly, Anhui Anfu Battery Technology Co.,Ltd's (SHSE:603031) stock price was strong on the back of its healthy earnings report. However, we think that shareholders may be missing some concerning details in the numbers.

See our latest analysis for Anhui Anfu Battery TechnologyLtd

Zooming In On Anhui Anfu Battery TechnologyLtd'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. 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.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Anhui Anfu Battery TechnologyLtd has an accrual ratio of -0.14 for the year to December 2023. 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¥804m, well over the CN¥115.8m it reported in profit. Anhui Anfu Battery TechnologyLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Anhui Anfu Battery TechnologyLtd expanded the number of shares on issue by 30% over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Anhui Anfu Battery TechnologyLtd's historical EPS growth by clicking on this link.

How Is Dilution Impacting Anhui Anfu Battery TechnologyLtd's Earnings Per Share (EPS)?

Three years ago, Anhui Anfu Battery TechnologyLtd lost money. The good news is that profit was up 42% in the last twelve months. On the other hand, earnings per share are only up 38% over the same period. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Anhui Anfu Battery TechnologyLtd shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Anhui Anfu Battery TechnologyLtd's Profit Performance

At the end of the day, Anhui Anfu Battery TechnologyLtd is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Given the contrasting considerations, we don't have a strong view as to whether Anhui Anfu Battery TechnologyLtd's profits are an apt reflection of its underlying potential for profit. If you'd like to know more about Anhui Anfu Battery TechnologyLtd as a business, it's important to be aware of any risks it's facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Anhui Anfu Battery TechnologyLtd.

Our examination of Anhui Anfu Battery TechnologyLtd 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. 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.