Nanjing CIGU TechnologyLTD (SHSE:688448) Strong Profits May Be Masking Some Underlying Issues

Following the solid earnings report from Nanjing CIGU Technology Corp.,LTD. (SHSE:688448), the market responded by bidding up the stock price. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

See our latest analysis for Nanjing CIGU TechnologyLTD

Zooming In On Nanjing CIGU TechnologyLTD'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Nanjing CIGU TechnologyLTD has an accrual ratio of 0.22 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥46m, in contrast to the aforementioned profit of CN¥50.0m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥46m, this year, indicates high risk. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nanjing CIGU TechnologyLTD.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥11m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. Nanjing CIGU TechnologyLTD had a rather significant contribution from unusual items relative to its profit to March 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 Nanjing CIGU TechnologyLTD's Profit Performance

Nanjing CIGU TechnologyLTD had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Nanjing CIGU TechnologyLTD's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Nanjing CIGU TechnologyLTD as a business, it's important to be aware of any risks it's facing. For instance, we've identified 2 warning signs for Nanjing CIGU TechnologyLTD (1 can't be ignored) you should be familiar with.

Our examination of Nanjing CIGU TechnologyLTD 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 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 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.