Xiangtan Yongda Machinery Manufacturing's (SZSE:001239) Weak Earnings May Only Reveal A Part Of The Whole Picture

Xiangtan Yongda Machinery Manufacturing Co., Ltd.'s (SZSE:001239) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Xiangtan Yongda Machinery Manufacturing

Examining Cashflow Against Xiangtan Yongda Machinery Manufacturing's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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 September 2024, Xiangtan Yongda Machinery Manufacturing had an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥74.7m, a look at free cash flow indicates it actually burnt through CN¥163m in the last year. We also note that Xiangtan Yongda Machinery Manufacturing's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥163m. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Xiangtan Yongda Machinery Manufacturing.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Xiangtan Yongda Machinery Manufacturing's profit was boosted by unusual items worth CN¥13m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. 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 Xiangtan Yongda Machinery Manufacturing's Profit Performance

Summing up, Xiangtan Yongda Machinery Manufacturing received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Xiangtan Yongda Machinery Manufacturing's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 1 warning sign for Xiangtan Yongda Machinery Manufacturing 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 with significant insider holdings 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.