Concerns Surrounding Senci Electric MachineryLtd's (SHSE:603109) Performance

The recent earnings posted by Senci Electric Machinery Co.,Ltd. (SHSE:603109) were solid, but the stock didn't move as much as we expected. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

View our latest analysis for Senci Electric MachineryLtd

A Closer Look At Senci Electric MachineryLtd'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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

Senci Electric MachineryLtd has an accrual ratio of 0.28 for the year to December 2023. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥21m despite its profit of CN¥226.1m, mentioned above. It's worth noting that Senci Electric MachineryLtd generated positive FCF of CN¥348m a year ago, so at least they've done it in the past. 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. One positive for Senci Electric MachineryLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Senci Electric MachineryLtd.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥19m, 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, after all, that's exactly what the accounting terminology implies. If Senci Electric MachineryLtd 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 Senci Electric MachineryLtd's Profit Performance

Summing up, Senci Electric MachineryLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Senci Electric MachineryLtd's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 3 warning signs for Senci Electric MachineryLtd (of which 1 is significant!) you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.