Concerns Surrounding Shenzhen Grandland Group's (SZSE:002482) Performance

Shenzhen Grandland Group Co., Ltd.'s (SZSE:002482) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Shenzhen Grandland Group

Zooming In On Shenzhen Grandland Group's 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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2024, Shenzhen Grandland Group recorded an accrual ratio of 2.50. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥2.60b, a look at free cash flow indicates it actually burnt through CN¥308m in the last year. We saw that FCF was CN¥5.1m a year ago though, so Shenzhen Grandland Group has at least been able to generate positive FCF in the past. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. The good news for shareholders is that Shenzhen Grandland Group's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Shenzhen Grandland Group expanded the number of shares on issue by 144% over the last year. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Shenzhen Grandland Group's EPS by clicking here.

A Look At The Impact Of Shenzhen Grandland Group's Dilution On Its Earnings Per Share (EPS)

Three years ago, Shenzhen Grandland Group lost money. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, if Shenzhen Grandland Group's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

How Do Unusual Items Influence Profit?

Shenzhen Grandland Group's profit suffered from unusual items, which reduced profit by CN¥888m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Shenzhen Grandland Group to produce a higher profit next year, all else being equal.

Our Take On Shenzhen Grandland Group's Profit Performance

In conclusion, Shenzhen Grandland Group's accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. On top of that, the dilution means that shareholders now own less of the company. Considering all this we'd argue Shenzhen Grandland Group's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 3 warning signs with Shenzhen Grandland Group, and understanding these should be part of your investment process.

Our examination of Shenzhen Grandland Group 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 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.