Suzhou Secote Precision ElectronicLTD's (SHSE:603283) Solid Earnings Are Supported By Other Strong Factors

Even though Suzhou Secote Precision Electronic Co.,LTD (SHSE:603283 ) posted strong earnings, investors appeared to be underwhelmed. We have done some analysis and have found some comforting factors beneath the profit numbers.

See our latest analysis for Suzhou Secote Precision ElectronicLTD

A Closer Look At Suzhou Secote Precision ElectronicLTD'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 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. 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 March 2024, Suzhou Secote Precision ElectronicLTD recorded an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥962m, well over the CN¥708.6m it reported in profit. Suzhou Secote Precision ElectronicLTD's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

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. In fact, Suzhou Secote Precision ElectronicLTD increased the number of shares on issue by 5.0% over the last twelve months by issuing new shares. 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 Suzhou Secote Precision ElectronicLTD's historical EPS growth by clicking on this link.

How Is Dilution Impacting Suzhou Secote Precision ElectronicLTD's Earnings Per Share (EPS)?

As you can see above, Suzhou Secote Precision ElectronicLTD has been growing its net income over the last few years, with an annualized gain of 310% over three years. But EPS was only up 279% per year, in the exact same period. And at a glance the 100% gain in profit over the last year impresses. On the other hand, earnings per share are only up 93% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Suzhou Secote Precision ElectronicLTD can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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.

The Impact Of Unusual Items On Profit

Suzhou Secote Precision ElectronicLTD's profit was reduced by unusual items worth CN¥126m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Suzhou Secote Precision ElectronicLTD to produce a higher profit next year, all else being equal.

Our Take On Suzhou Secote Precision ElectronicLTD's Profit Performance

In conclusion, both Suzhou Secote Precision ElectronicLTD's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative, but the dilution means that per-share performance is weaker than the statutory profit numbers imply. Looking at all these factors, we'd say that Suzhou Secote Precision ElectronicLTD's underlying earnings power is at least as good as the statutory numbers would make it seem. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for Suzhou Secote Precision ElectronicLTD you should know about.

Our examination of Suzhou Secote Precision ElectronicLTD has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.