Xiamen East Asia Machinery Industrial's (SZSE:301028) Shareholders May Want To Dig Deeper Than Statutory Profit

The market for Xiamen East Asia Machinery Industrial Co., Ltd.'s (SZSE:301028) stock was strong after it released a healthy earnings report last week. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

Check out our latest analysis for Xiamen East Asia Machinery Industrial

Zooming In On Xiamen East Asia Machinery Industrial'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). 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. 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. 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.

Xiamen East Asia Machinery Industrial has an accrual ratio of 0.23 for the year to June 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of CN¥26m in the last year, which was a lot less than its statutory profit of CN¥192.4m. Xiamen East Asia Machinery Industrial shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. The good news for shareholders is that Xiamen East Asia Machinery Industrial's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Xiamen East Asia Machinery Industrial.

Our Take On Xiamen East Asia Machinery Industrial's Profit Performance

Xiamen East Asia Machinery Industrial didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Xiamen East Asia Machinery Industrial's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 27% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. 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. For example, Xiamen East Asia Machinery Industrial has 2 warning signs (and 1 which is potentially serious) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Xiamen East Asia Machinery Industrial's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with high insider ownership.

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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.