Ginlong Technologies' (SZSE:300763) Earnings Quality Is Low

Shareholders didn't appear too concerned by Ginlong Technologies Co., Ltd.'s (SZSE:300763) weak earnings. We did some analysis and found some concerning details beneath the statutory profit number.

See our latest analysis for Ginlong Technologies

A Closer Look At Ginlong Technologies' 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. 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.

For the year to March 2024, Ginlong Technologies had an accrual ratio of 0.59. 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¥475.5m, a look at free cash flow indicates it actually burnt through CN¥7.4b in the last year. We also note that Ginlong Technologies' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥7.4b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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. As it happens, Ginlong Technologies issued 8.1% more new shares over the last year. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Ginlong Technologies' historical EPS growth by clicking on this link.

How Is Dilution Impacting Ginlong Technologies' Earnings Per Share (EPS)?

As you can see above, Ginlong Technologies has been growing its net income over the last few years, with an annualized gain of 30% over three years. In comparison, earnings per share only gained 17% over the same period. Net income was down 61% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 63%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Ginlong Technologies' earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Ginlong Technologies' Profit Performance

As it turns out, Ginlong Technologies couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Ginlong Technologies' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Ginlong Technologies as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with Ginlong Technologies (including 2 which can't be ignored).

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. 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.