We Think That There Are More Issues For Hefei Jianghang Aircraft Equipment (SHSE:688586) Than Just Sluggish Earnings

The subdued market reaction suggests that Hefei Jianghang Aircraft Equipment Corporation Ltd.'s (SHSE:688586) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Hefei Jianghang Aircraft Equipment

Zooming In On Hefei Jianghang Aircraft Equipment'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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2023, Hefei Jianghang Aircraft Equipment had an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥1.5m despite its profit of CN¥193.0m, mentioned above. We saw that FCF was CN¥104m a year ago though, so Hefei Jianghang Aircraft Equipment has at least been able to generate positive FCF in the past. However, that's not all there is to consider. 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 Hefei Jianghang Aircraft Equipment.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥23m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. If Hefei Jianghang Aircraft Equipment doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Hefei Jianghang Aircraft Equipment's Profit Performance

Hefei Jianghang Aircraft Equipment had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Hefei Jianghang Aircraft Equipment's statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Hefei Jianghang Aircraft Equipment has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

Our examination of Hefei Jianghang Aircraft Equipment 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. 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.