Dongfang Electronics' (SZSE:000682) Performance Is Even Better Than Its Earnings Suggest

When companies post strong earnings, the stock generally performs well, just like Dongfang Electronics Co., Ltd.'s (SZSE:000682) stock has recently. Our analysis found some more factors that we think are good for shareholders.

Check out our latest analysis for Dongfang Electronics

Zooming In On Dongfang Electronics' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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, Dongfang Electronics had an accrual ratio of -0.26. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥1.1b during the period, dwarfing its reported profit of CN¥541.3m. Dongfang Electronics' free cash flow improved over the last year, which is generally good to see. 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.

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.

How Do Unusual Items Influence Profit?

Surprisingly, given Dongfang Electronics' accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥92m in unusual items. 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'. 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 Dongfang Electronics' Profit Performance

Dongfang Electronics' profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that Dongfang Electronics' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into Dongfang Electronics, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Dongfang Electronics, and understanding it should be part of your investment process.

Our examination of Dongfang Electronics has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.