We Think That There Are More Issues For Kunshan Dongwei TechnologyLtd (SHSE:688700) Than Just Sluggish Earnings

Kunshan Dongwei Technology Co.,Ltd.'s (SHSE:688700) stock showed strength, with investors undeterred by its weak earnings report. We think that shareholders might be missing some concerning factors that our analysis found.

See our latest analysis for Kunshan Dongwei TechnologyLtd

Zooming In On Kunshan Dongwei TechnologyLtd'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Kunshan Dongwei TechnologyLtd has an accrual ratio of 0.35 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of CN¥180m, in contrast to the aforementioned profit of CN¥151.4m. We also note that Kunshan Dongwei TechnologyLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥180m. 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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Kunshan Dongwei TechnologyLtd expanded the number of shares on issue by 5.4% over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Kunshan Dongwei TechnologyLtd's EPS by clicking here.

How Is Dilution Impacting Kunshan Dongwei TechnologyLtd's Earnings Per Share (EPS)?

Kunshan Dongwei TechnologyLtd has improved its profit over the last three years, with an annualized gain of 72% in that time. In comparison, earnings per share only gained 26% over the same period. Net profit actually dropped by 29% in the last year. But the EPS result was even worse, with the company recording a decline of 31%. So you can see that the dilution has had a bit of an impact on shareholders.

If Kunshan Dongwei TechnologyLtd's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Kunshan Dongwei TechnologyLtd's Profit Performance

As it turns out, Kunshan Dongwei TechnologyLtd 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). Considering all this we'd argue Kunshan Dongwei TechnologyLtd's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Kunshan Dongwei TechnologyLtd at this point in time. Our analysis shows 3 warning signs for Kunshan Dongwei TechnologyLtd (1 is concerning!) and we strongly recommend you look at these before investing.

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 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.