Pylon Technologies' (SHSE:688063) Sluggish Earnings Might Be Just The Beginning Of Its Problems

The market wasn't impressed with the soft earnings from Pylon Technologies Co., Ltd. (SHSE:688063) recently. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

View our latest analysis for Pylon Technologies

Examining Cashflow Against Pylon Technologies' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Pylon Technologies recorded an accrual ratio of 0.22. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥515.6m, a look at free cash flow indicates it actually burnt through CN¥129m in the last year. We saw that FCF was CN¥177m a year ago though, so Pylon Technologies has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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?

Given the accrual ratio, it's not overly surprising that Pylon Technologies' profit was boosted by unusual items worth CN¥68m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Pylon Technologies' Profit Performance

Pylon Technologies had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Pylon Technologies' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Pylon Technologies as a business, it's important to be aware of any risks it's facing. For example, Pylon Technologies has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Our examination of Pylon Technologies has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.