GuangDong Suqun New MaterialLtd's (SZSE:301489) Sluggish Earnings Might Be Just The Beginning Of Its Problems

Despite GuangDong Suqun New Material Co.,Ltd.'s (SZSE:301489) recent earnings report having lackluster headline numbers, the market responded positively. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

See our latest analysis for GuangDong Suqun New MaterialLtd

Zooming In On GuangDong Suqun New MaterialLtd'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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

GuangDong Suqun New MaterialLtd has an accrual ratio of 0.21 for the year to March 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥51.6m, a look at free cash flow indicates it actually burnt through CN¥60m in the last year. We also note that GuangDong Suqun New MaterialLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥60m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of GuangDong Suqun New MaterialLtd.

Our Take On GuangDong Suqun New MaterialLtd's Profit Performance

GuangDong Suqun New MaterialLtd 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 GuangDong Suqun New MaterialLtd's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing GuangDong Suqun New MaterialLtd at this point in time. Every company has risks, and we've spotted 2 warning signs for GuangDong Suqun New MaterialLtd you should know about.

This note has only looked at a single factor that sheds light on the nature of GuangDong Suqun New MaterialLtd's profit. 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. 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.