There Are Some Reasons To Suggest That Wuhan Yifi Laser's (SHSE:688646) Earnings Are A Poor Reflection Of Profitability

Investors appear disappointed with Wuhan Yifi Laser Corporation Limited's (SHSE:688646) recent earnings, despite the decent statutory profit number. We think that they may be worried about something else, so we did some analysis and found that investors have noticed some soft numbers underlying the profit.

Check out our latest analysis for Wuhan Yifi Laser

A Closer Look At Wuhan Yifi Laser's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to September 2024, Wuhan Yifi Laser had an accrual ratio of 0.40. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥204m despite its profit of CN¥106.4m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥204m, 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 Wuhan Yifi Laser.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Wuhan Yifi Laser's profit was boosted by unusual items worth CN¥31m 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 that's as you'd expect, given these boosts are described as 'unusual'. We can see that Wuhan Yifi Laser's positive unusual items were quite significant relative to its profit in the year to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Wuhan Yifi Laser's Profit Performance

Wuhan Yifi Laser had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Wuhan Yifi Laser's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Wuhan Yifi Laser as a business, it's important to be aware of any risks it's facing. For example, we've found that Wuhan Yifi Laser has 2 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

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 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.