We Think ShenZhen QiangRui Precision Technology's (SZSE:301128) Solid Earnings Are Understated

ShenZhen QiangRui Precision Technology Co., Ltd.'s (SZSE:301128) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

See our latest analysis for ShenZhen QiangRui Precision Technology

Examining Cashflow Against ShenZhen QiangRui Precision Technology's 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. 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. 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. 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.

Over the twelve months to December 2023, ShenZhen QiangRui Precision Technology recorded an accrual ratio of 0.20. 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¥55.7m, a look at free cash flow indicates it actually burnt through CN¥26m 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¥26m, this year, indicates high risk. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ShenZhen QiangRui Precision Technology.

The Impact Of Unusual Items On Profit

ShenZhen QiangRui Precision Technology's profit suffered from unusual items, which reduced profit by CN¥16m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect ShenZhen QiangRui Precision Technology to produce a higher profit next year, all else being equal.

Our Take On ShenZhen QiangRui Precision Technology's Profit Performance

In conclusion, ShenZhen QiangRui Precision Technology's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Considering the aforementioned, we think that ShenZhen QiangRui Precision Technology's profits are probably a reasonable reflection of its underlying profitability; although we'd be confident in that conclusion if we saw a cleaner set of results. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that ShenZhen QiangRui Precision Technology has 4 warning signs and it would be unwise to ignore them.

Our examination of ShenZhen QiangRui Precision Technology has focussed on certain factors that can make its earnings look better than they are. 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 that insiders are buying 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.