Yuhuan CNC Machine ToolLtd's (SZSE:002903) Problems Go Beyond Weak Profit

The market shrugged off Yuhuan CNC Machine Tool Co.,Ltd.'s (SZSE:002903) weak earnings report last week. We looked at the details, and we think that investors may be responding to some encouraging factors.

See our latest analysis for Yuhuan CNC Machine ToolLtd

Zooming In On Yuhuan CNC Machine ToolLtd'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. 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2024, Yuhuan CNC Machine ToolLtd recorded an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥104m, well over the CN¥32.4m it reported in profit. Given that Yuhuan CNC Machine ToolLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥104m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Yuhuan CNC Machine ToolLtd's profit was boosted by unusual items worth CN¥8.2m in the last twelve months. 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. And, after all, that's exactly what the accounting terminology implies. If Yuhuan CNC Machine ToolLtd 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 Yuhuan CNC Machine ToolLtd's Profit Performance

Yuhuan CNC Machine ToolLtd'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. Having considered these factors, we don't think Yuhuan CNC Machine ToolLtd's statutory profits give an overly harsh view of the business. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 3 warning signs with Yuhuan CNC Machine ToolLtd, and understanding these bad boys should be part of your investment process.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.