Why Xinlei Compressor's (SZSE:301317) Shaky Earnings Are Just The Beginning Of Its Problems

A lackluster earnings announcement from Xinlei Compressor Co., Ltd. (SZSE:301317) last week didn't sink the stock price. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out our latest analysis for Xinlei Compressor

Examining Cashflow Against Xinlei Compressor'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. 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. 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".

For the year to March 2024, Xinlei Compressor had an accrual ratio of 1.31. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥516m, in contrast to the aforementioned profit of CN¥56.7m. It's worth noting that Xinlei Compressor generated positive FCF of CN¥77m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Xinlei Compressor.

Our Take On Xinlei Compressor's Profit Performance

As we discussed above, we think Xinlei Compressor's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Xinlei Compressor's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased 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. If you want to do dive deeper into Xinlei Compressor, you'd also look into what risks it is currently facing. For instance, we've identified 4 warning signs for Xinlei Compressor (1 makes us a bit uncomfortable) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Xinlei Compressor'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 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.