Investors Shouldn't Be Too Comfortable With IFE Elevators' (SZSE:002774) Earnings

IFE Elevators Co., Ltd. (SZSE:002774) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

See our latest analysis for IFE Elevators

A Closer Look At IFE Elevators' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

IFE Elevators has an accrual ratio of 0.34 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Indeed, in the last twelve months it reported free cash flow of CN¥37m, which is significantly less than its profit of CN¥161.9m. We note, however, that IFE Elevators grew its free cash flow over the last year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of IFE Elevators.

Our Take On IFE Elevators' Profit Performance

As we have made quite clear, we're a bit worried that IFE Elevators didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that IFE Elevators' underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing IFE Elevators at this point in time. Case in point: We've spotted 2 warning signs for IFE Elevators you should be mindful of and 1 of these bad boys doesn't sit too well with us.

Today we've zoomed in on a single data point to better understand the nature of IFE Elevators' profit. 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. 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.