Huachangda Intelligent Equipment GroupLtd's (SZSE:300278) Anemic Earnings Might Be Worse Than You Think

The subdued market reaction suggests that Huachangda Intelligent Equipment Group Co.,Ltd.'s (SZSE:300278) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Huachangda Intelligent Equipment GroupLtd

A Closer Look At Huachangda Intelligent Equipment GroupLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, Huachangda Intelligent Equipment GroupLtd recorded an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥85.6m, a look at free cash flow indicates it actually burnt through CN¥169m in the last year. We also note that Huachangda Intelligent Equipment GroupLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥169m. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Huachangda Intelligent Equipment GroupLtd.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Huachangda Intelligent Equipment GroupLtd's profit was boosted by unusual items worth CN¥11m 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Huachangda Intelligent Equipment GroupLtd's Profit Performance

Summing up, Huachangda Intelligent Equipment GroupLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Huachangda Intelligent Equipment GroupLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Huachangda Intelligent Equipment GroupLtd as a business, it's important to be aware of any risks it's facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Huachangda Intelligent Equipment GroupLtd.

Our examination of Huachangda Intelligent Equipment GroupLtd 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 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.