Shareholders Will Be Pleased With The Quality of Zhongtong Bus HoldingLTD's (SZSE:000957) Earnings

The subdued stock price reaction suggests that Zhongtong Bus Holding Co.,LTD's (SZSE:000957) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

View our latest analysis for Zhongtong Bus HoldingLTD

A Closer Look At Zhongtong Bus HoldingLTD'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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Zhongtong Bus HoldingLTD recorded an accrual ratio of -1.23. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥1.4b during the period, dwarfing its reported profit of CN¥191.2m. Zhongtong Bus HoldingLTD's 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhongtong Bus HoldingLTD.

How Do Unusual Items Influence Profit?

Surprisingly, given Zhongtong Bus HoldingLTD's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥54m 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'. If Zhongtong Bus HoldingLTD doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Zhongtong Bus HoldingLTD's Profit Performance

In conclusion, Zhongtong Bus HoldingLTD's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think that Zhongtong Bus HoldingLTD's profits are a reasonably conservative guide to its underlying profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Zhongtong Bus HoldingLTD has 1 warning sign we think you should be aware of.

Our examination of Zhongtong Bus HoldingLTD has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.