We Think That There Are Issues Underlying Guangzhou Risong Intelligent Technology Holding's (SHSE:688090) Earnings

Last week's profit announcement from Guangzhou Risong Intelligent Technology Holding Co., Ltd. (SHSE:688090) was underwhelming for investors, despite headline numbers being robust. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

View our latest analysis for Guangzhou Risong Intelligent Technology Holding

Examining Cashflow Against Guangzhou Risong Intelligent Technology Holding's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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".

Guangzhou Risong Intelligent Technology Holding has an accrual ratio of -0.11 for the year to September 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of CN¥110m during the period, dwarfing its reported profit of CN¥34.1m. Notably, Guangzhou Risong Intelligent Technology Holding had negative free cash flow last year, so the CN¥110m it produced this year was a welcome improvement. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangzhou Risong Intelligent Technology Holding.

The Impact Of Unusual Items On Profit

Surprisingly, given Guangzhou Risong Intelligent Technology Holding's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥22m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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 that's as you'd expect, given these boosts are described as 'unusual'. Guangzhou Risong Intelligent Technology Holding had a rather significant contribution from unusual items relative to its profit to September 2024. 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 Guangzhou Risong Intelligent Technology Holding's Profit Performance

In conclusion, Guangzhou Risong Intelligent Technology Holding's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Having considered these factors, we don't think Guangzhou Risong Intelligent Technology Holding's statutory profits give an overly harsh view of the business. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that Guangzhou Risong Intelligent Technology Holding is showing 3 warning signs in our investment analysis and 2 of those are a bit concerning...

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. 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. 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 with significant insider holdings 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.