Why Hengdian Group Tospo Lighting's (SHSE:603303) Earnings Are Better Than They Seem

Hengdian Group Tospo Lighting Co., Ltd.'s (SHSE:603303) solid earnings announcement recently didn't do much to the stock price. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

View our latest analysis for Hengdian Group Tospo Lighting

Zooming In On Hengdian Group Tospo Lighting'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). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to December 2023, Hengdian Group Tospo Lighting had an accrual ratio of -0.22. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥676m during the period, dwarfing its reported profit of CN¥375.6m. Hengdian Group Tospo Lighting did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. 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.

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.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Hengdian Group Tospo Lighting's profit was boosted by unusual items worth CN¥82m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. Hengdian Group Tospo Lighting had a rather significant contribution from unusual items relative to its profit to December 2023. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Hengdian Group Tospo Lighting's Profit Performance

In conclusion, Hengdian Group Tospo Lighting's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. After taking into account all these factors, we think that Hengdian Group Tospo Lighting's statutory results are a decent reflection of its underlying earnings power. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 2 warning signs with Hengdian Group Tospo Lighting, and understanding these should be part of your investment process.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.