Eaglerise Electric & Electronic (China)'s (SZSE:002922) Shareholders May Want To Dig Deeper Than Statutory Profit

Eaglerise Electric & Electronic (China) Co., Ltd's (SZSE:002922) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for Eaglerise Electric & Electronic (China)

Zooming In On Eaglerise Electric & Electronic (China)'s 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

For the year to December 2023, Eaglerise Electric & Electronic (China) had an accrual ratio of 0.29. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of CN¥209.3m, a look at free cash flow indicates it actually burnt through CN¥376m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥376m, this year, indicates high risk. However, that's not the end of the story. 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.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Eaglerise Electric & Electronic (China) increased the number of shares on issue by 30% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Eaglerise Electric & Electronic (China)'s historical EPS growth by clicking on this link.

A Look At The Impact Of Eaglerise Electric & Electronic (China)'s Dilution On Its Earnings Per Share (EPS)

Eaglerise Electric & Electronic (China) has improved its profit over the last three years, with an annualized gain of 307% in that time. But EPS was only up 215% per year, in the exact same period. And over the last 12 months, the company grew its profit by 9.3%. On the other hand, earnings per share are pretty much flat, over the last twelve months. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, if Eaglerise Electric & Electronic (China)'s earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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.

The Impact Of Unusual Items On Profit

Eaglerise Electric & Electronic (China)'s profit suffered from unusual items, which reduced profit by CN¥83m 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Eaglerise Electric & Electronic (China) to produce a higher profit next year, all else being equal.

Our Take On Eaglerise Electric & Electronic (China)'s Profit Performance

In conclusion, Eaglerise Electric & Electronic (China)'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. Based on these factors, we think that Eaglerise Electric & Electronic (China)'s statutory profits probably make it seem better than it is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 3 warning signs for Eaglerise Electric & Electronic (China) (1 is potentially serious) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.