The Strong Earnings Posted By Guangzhou Tech-Long Packaging MachineryLtd (SZSE:002209) Are A Good Indication Of The Strength Of The Business

Guangzhou Tech-Long Packaging Machinery Co.,Ltd.'s (SZSE:002209) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We have done some analysis and have found some comforting factors beneath the profit numbers.

See our latest analysis for Guangzhou Tech-Long Packaging MachineryLtd

Examining Cashflow Against Guangzhou Tech-Long Packaging MachineryLtd'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Guangzhou Tech-Long Packaging MachineryLtd has an accrual ratio of -0.49 for the year to September 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of CN¥227m in the last year, which was a lot more than its statutory profit of CN¥40.8m. Guangzhou Tech-Long Packaging MachineryLtd'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 Guangzhou Tech-Long Packaging MachineryLtd.

The Impact Of Unusual Items On Profit

Surprisingly, given Guangzhou Tech-Long Packaging MachineryLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥6.7m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. Which is hardly surprising, given the name. 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 Guangzhou Tech-Long Packaging MachineryLtd's Profit Performance

Guangzhou Tech-Long Packaging MachineryLtd's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that Guangzhou Tech-Long Packaging MachineryLtd's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. While earnings are important, another area to consider is the balance sheet. You can see our latest analysis on Guangzhou Tech-Long Packaging MachineryLtd's balance sheet health here.

Our examination of Guangzhou Tech-Long Packaging MachineryLtd 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.