We Think That There Are More Issues For Foshan Golden Milky Way Intelligent Equipment (SZSE:300619) Than Just Sluggish Earnings

The recent earnings release from Foshan Golden Milky Way Intelligent Equipment Co., Ltd. (SZSE:300619 ) was disappointing to investors. We looked deeper and believe that there is even more to be worried about, beyond the soft profit numbers.

See our latest analysis for Foshan Golden Milky Way Intelligent Equipment

Examining Cashflow Against Foshan Golden Milky Way Intelligent Equipment's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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.

Foshan Golden Milky Way Intelligent Equipment has an accrual ratio of 0.40 for the year to March 2024. 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¥57.8m, a look at free cash flow indicates it actually burnt through CN¥694m in the last year. It's worth noting that Foshan Golden Milky Way Intelligent Equipment generated positive FCF of CN¥109m a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. One positive for Foshan Golden Milky Way Intelligent Equipment shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Foshan Golden Milky Way Intelligent Equipment.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Foshan Golden Milky Way Intelligent Equipment increased the number of shares on issue by 16% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Foshan Golden Milky Way Intelligent Equipment's historical EPS growth by clicking on this link.

A Look At The Impact Of Foshan Golden Milky Way Intelligent Equipment's Dilution On Its Earnings Per Share (EPS)

Foshan Golden Milky Way Intelligent Equipment has improved its profit over the last three years, with an annualized gain of 203% in that time. But EPS was only up 144% per year, in the exact same period. Net profit actually dropped by 40% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 43%. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, if Foshan Golden Milky Way Intelligent Equipment'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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Foshan Golden Milky Way Intelligent Equipment's Profit Performance

In conclusion, Foshan Golden Milky Way Intelligent Equipment has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Foshan Golden Milky Way Intelligent Equipment's statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 4 warning signs for Foshan Golden Milky Way Intelligent Equipment (1 is significant!) that we believe deserve your full attention.

Our examination of Foshan Golden Milky Way Intelligent Equipment 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.