We Think Guangzhou Tech-Long Packaging MachineryLtd's (SZSE:002209) Profit Is Only A Baseline For What They Can Achieve

Last week's profit announcement from Guangzhou Tech-Long Packaging Machinery Co.,Ltd. (SZSE:002209) was underwhelming for investors, despite headline numbers being robust. We think that the market might be paying attention to some underlying factors that they find to be concerning.

See our latest analysis for Guangzhou Tech-Long Packaging MachineryLtd

A Closer Look At Guangzhou Tech-Long Packaging MachineryLtd'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. 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.

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. 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 December 2023, Guangzhou Tech-Long Packaging MachineryLtd recorded an accrual ratio of -0.27. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥190m in the last year, which was a lot more than its statutory profit of CN¥46.6m. Guangzhou Tech-Long Packaging MachineryLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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 Guangzhou Tech-Long Packaging MachineryLtd.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Guangzhou Tech-Long Packaging MachineryLtd's profit was boosted by unusual items worth CN¥25m 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 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. Guangzhou Tech-Long Packaging MachineryLtd had a rather significant contribution from unusual items relative to its profit to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Guangzhou Tech-Long Packaging MachineryLtd's Profit Performance

In conclusion, Guangzhou Tech-Long Packaging MachineryLtd's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don't have a strong view as to whether Guangzhou Tech-Long Packaging MachineryLtd's profits are an apt reflection of its underlying potential for profit. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example - Guangzhou Tech-Long Packaging MachineryLtd has 2 warning signs we think you should be aware of.

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 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. 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.