There Are Some Holes In Sinosteel Engineering & Technology's (SZSE:000928) Solid Earnings Release

Shareholders didn't seem to be thrilled with Sinosteel Engineering & Technology Co., Ltd.'s (SZSE:000928) recent earnings report, despite healthy profit numbers. We think that they might be concerned about some underlying details that our analysis found.

See our latest analysis for Sinosteel Engineering & Technology

Examining Cashflow Against Sinosteel Engineering & Technology'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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Sinosteel Engineering & Technology has an accrual ratio of 0.85 for the year to March 2024. 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¥541m despite its profit of CN¥768.3m, mentioned above. We saw that FCF was CN¥1.8b a year ago though, so Sinosteel Engineering & Technology has at least been able to generate positive FCF in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings. One positive for Sinosteel Engineering & Technology shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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. Sinosteel Engineering & Technology expanded the number of shares on issue by 12% over the last year. As a result, its net income is now split between a greater number of shares. 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 Sinosteel Engineering & Technology's EPS by clicking here.

How Is Dilution Impacting Sinosteel Engineering & Technology's Earnings Per Share (EPS)?

As you can see above, Sinosteel Engineering & Technology has been growing its net income over the last few years, with an annualized gain of 7.3% over three years. In contrast, earnings per share were actually down by 0.6% per year, in the exact same period. And over the last 12 months, the company grew its profit by 8.1%. On the other hand, earnings per share are only up 2.1% in that time. 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 Sinosteel Engineering & Technology shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Sinosteel Engineering & Technology's Profit Performance

As it turns out, Sinosteel Engineering & Technology couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Sinosteel Engineering & Technology's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Sinosteel Engineering & Technology has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.