We Think That There Are Some Issues For Guangzhou Metro Design & Research Institute (SZSE:003013) Beyond Its Promising Earnings

Guangzhou Metro Design & Research Institute Co., Ltd.'s (SZSE:003013) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

See our latest analysis for Guangzhou Metro Design & Research Institute

Zooming In On Guangzhou Metro Design & Research Institute'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. 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 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.

Guangzhou Metro Design & Research Institute has an accrual ratio of 0.48 for the year to December 2023. 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¥431.9m, a look at free cash flow indicates it actually burnt through CN¥106m in the last year. We saw that FCF was CN¥188m a year ago though, so Guangzhou Metro Design & Research Institute has at least been able to generate positive FCF in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

Guangzhou Metro Design & Research Institute's profit suffered from unusual items, which reduced profit by CN¥64m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Guangzhou Metro Design & Research Institute doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Guangzhou Metro Design & Research Institute's Profit Performance

In conclusion, Guangzhou Metro Design & Research Institute's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Based on these factors, we think it's very unlikely that Guangzhou Metro Design & Research Institute's statutory profits make it seem much weaker than it is. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Guangzhou Metro Design & Research Institute is showing 2 warning signs in our investment analysis and 1 of those shouldn't be ignored...

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. 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.