Shenzhen SNC Opto ElectronicLtd's (SZSE:001326) Profits May Not Reveal Underlying Issues

Shenzhen SNC Opto Electronic Co.,Ltd (SZSE:001326) just released a solid earnings report, and the stock displayed some strength. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

See our latest analysis for Shenzhen SNC Opto ElectronicLtd

A Closer Look At Shenzhen SNC Opto ElectronicLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Shenzhen SNC Opto ElectronicLtd has an accrual ratio of 0.43 for the year to December 2023. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of CN¥71m during the period, falling well short of its reported profit of CN¥153.3m. Shenzhen SNC Opto ElectronicLtd shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen SNC Opto ElectronicLtd.

Our Take On Shenzhen SNC Opto ElectronicLtd's Profit Performance

As we have made quite clear, we're a bit worried that Shenzhen SNC Opto ElectronicLtd didn't back up the last year's profit with free cashflow. For this reason, we think that Shenzhen SNC Opto ElectronicLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 11% EPS growth in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Shenzhen SNC Opto ElectronicLtd as a business, it's important to be aware of any risks it's facing. For example - Shenzhen SNC Opto ElectronicLtd has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Shenzhen SNC Opto ElectronicLtd's profit. 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. 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.