SolaX Power Network Technology (Zhejiang)'s (SHSE:688717) Problems Go Beyond Poor Profit

The recent earnings release from SolaX Power Network Technology (Zhejiang) Co., Ltd. (SHSE:688717 ) was disappointing to investors. We think that they may have more to worry about than just soft profit numbers.

View our latest analysis for SolaX Power Network Technology (Zhejiang)

Zooming In On SolaX Power Network Technology (Zhejiang)'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Over the twelve months to March 2024, SolaX Power Network Technology (Zhejiang) recorded an accrual ratio of 0.68. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥595.2m, a look at free cash flow indicates it actually burnt through CN¥72m in the last year. It's worth noting that SolaX Power Network Technology (Zhejiang) generated positive FCF of CN¥589m a year ago, so at least they've done it in the past. 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 SolaX Power Network Technology (Zhejiang).

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that SolaX Power Network Technology (Zhejiang)'s profit was boosted by unusual items worth CN¥58m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On SolaX Power Network Technology (Zhejiang)'s Profit Performance

Summing up, SolaX Power Network Technology (Zhejiang) received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at SolaX Power Network Technology (Zhejiang)'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. Every company has risks, and we've spotted 1 warning sign for SolaX Power Network Technology (Zhejiang) you should know about.

Our examination of SolaX Power Network Technology (Zhejiang) 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 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.