Beyond Lackluster Earnings: Potential Concerns For Nanchang Mineral Systems' (SZSE:001360) Shareholders

The market shrugged off Nanchang Mineral Systems Co., Ltd.'s (SZSE:001360) weak earnings report. Despite the strength in the stock, we feel that investors should be cautious about some numbers in the earnings.

See our latest analysis for Nanchang Mineral Systems

Zooming In On Nanchang Mineral Systems' 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Nanchang Mineral Systems has an accrual ratio of 0.48 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. Over the last year it actually had negative free cash flow of CN¥203m, in contrast to the aforementioned profit of CN¥95.8m. We saw that FCF was CN¥55m a year ago though, so Nanchang Mineral Systems has at least been able to generate positive FCF in the past. Having said that, there is more to the story. 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 Nanchang Mineral Systems.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Nanchang Mineral Systems' profit was boosted by unusual items worth CN¥18m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Nanchang Mineral Systems 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 Nanchang Mineral Systems' Profit Performance

Nanchang Mineral Systems had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Nanchang Mineral Systems' 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 2 warning signs for Nanchang Mineral Systems (of which 1 can't be ignored!) you should know about.

Our examination of Nanchang Mineral Systems has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.