Ningbo Zhenyu Technology's (SZSE:300953) Promising Earnings May Rest On Soft Foundations

Ningbo Zhenyu Technology Co., Ltd.'s (SZSE:300953) stock was strong after they recently reported robust earnings. However, we think that shareholders may be missing some concerning details in the numbers.

View our latest analysis for Ningbo Zhenyu Technology

Examining Cashflow Against Ningbo Zhenyu Technology'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Ningbo Zhenyu Technology has an accrual ratio of 0.21 for the year to September 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥160.3m, a look at free cash flow indicates it actually burnt through CN¥1.0b 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¥1.0b, this year, indicates high risk. Having said that, there is more to the story. 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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Ningbo Zhenyu Technology's profit was boosted by unusual items worth CN¥44m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Ningbo Zhenyu Technology doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Ningbo Zhenyu Technology's Profit Performance

Ningbo Zhenyu Technology had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Ningbo Zhenyu Technology's profits probably give an overly generous impression of its sustainable level of profitability. 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. In terms of investment risks, we've identified 2 warning signs with Ningbo Zhenyu Technology, and understanding these should be part of your investment process.

Our examination of Ningbo Zhenyu Technology 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. 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 with significant insider holdings 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.