Dalian Haosen Equipment Manufacturing's (SHSE:688529) Weak Earnings Might Be Worse Than They Appear

Shareholders didn't appear too concerned by Dalian Haosen Equipment Manufacturing Co., Ltd.'s (SHSE:688529) weak earnings. We did some analysis and found some concerning details beneath the statutory profit number.

Check out our latest analysis for Dalian Haosen Equipment Manufacturing

Zooming In On Dalian Haosen Equipment Manufacturing'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). 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 March 2024, Dalian Haosen Equipment Manufacturing had an accrual ratio of 0.46. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥65.0m, a look at free cash flow indicates it actually burnt through CN¥1.1b in the last year. We also note that Dalian Haosen Equipment Manufacturing's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.1b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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. As it happens, Dalian Haosen Equipment Manufacturing issued 31% more new shares over the last year. 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 Dalian Haosen Equipment Manufacturing's historical EPS growth by clicking on this link.

How Is Dilution Impacting Dalian Haosen Equipment Manufacturing's Earnings Per Share (EPS)?

As you can see above, Dalian Haosen Equipment Manufacturing has been growing its net income over the last few years, with an annualized gain of 3.7% over three years. But on the other hand, earnings per share actually fell by 23% per year. Net profit actually dropped by 29% in the last year. But the EPS result was even worse, with the company recording a decline of 37%. So you can see that the dilution has had a fairly significant impact on shareholders.

If Dalian Haosen Equipment Manufacturing's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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.

Our Take On Dalian Haosen Equipment Manufacturing's Profit Performance

As it turns out, Dalian Haosen Equipment Manufacturing couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For the reasons mentioned above, we think that a perfunctory glance at Dalian Haosen Equipment Manufacturing's statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, Dalian Haosen Equipment Manufacturing has 5 warning signs (and 2 which are significant) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.