Suzhou Veichi Electric (SHSE:688698) Shareholders Should Be Cautious Despite Solid Earnings

Shareholders were pleased with the recent earnings report from Suzhou Veichi Electric Co., Ltd. (SHSE:688698). Investors should be cautious however, as there some causes of concern deeper in the numbers.

View our latest analysis for Suzhou Veichi Electric

Zooming In On Suzhou Veichi Electric's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

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".

Suzhou Veichi Electric has an accrual ratio of 0.36 for the year to December 2023. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥177m, in contrast to the aforementioned profit of CN¥190.8m. It's worth noting that Suzhou Veichi Electric generated positive FCF of CN¥89m a year ago, so at least they've done it in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Suzhou Veichi Electric increased the number of shares on issue by 17% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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 Suzhou Veichi Electric's historical EPS growth by clicking on this link.

How Is Dilution Impacting Suzhou Veichi Electric's Earnings Per Share (EPS)?

Suzhou Veichi Electric has improved its profit over the last three years, with an annualized gain of 118% in that time. In comparison, earnings per share only gained 57% over the same period. And at a glance the 36% gain in profit over the last year impresses. But in comparison, EPS only increased by 31% over the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Suzhou Veichi Electric can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Suzhou Veichi Electric's Profit Performance

As it turns out, Suzhou Veichi Electric couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at Suzhou Veichi Electric'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. To that end, you should learn about the 3 warning signs we've spotted with Suzhou Veichi Electric (including 1 which doesn't sit too well with us).

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.