Shenzhen Intelligent Precision Instrument's (SZSE:301512) Shareholders Have More To Worry About Than Only Soft Earnings

Investors were disappointed by Shenzhen Intelligent Precision Instrument Co., Ltd.'s (SZSE:301512 ) latest earnings release. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

Check out our latest analysis for Shenzhen Intelligent Precision Instrument

Examining Cashflow Against Shenzhen Intelligent Precision Instrument'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".

For the year to September 2024, Shenzhen Intelligent Precision Instrument had an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥109m despite its profit of CN¥12.3m, mentioned above. We saw that FCF was CN¥3.2m a year ago though, so Shenzhen Intelligent Precision Instrument has at least been able to generate positive FCF in the past. Having said that, there is more to the story. 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 Intelligent Precision Instrument.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥1.2m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Shenzhen Intelligent Precision Instrument's Profit Performance

Summing up, Shenzhen Intelligent Precision Instrument received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Shenzhen Intelligent Precision Instrument's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Shenzhen Intelligent Precision Instrument, you'd also look into what risks it is currently facing. For instance, we've identified 4 warning signs for Shenzhen Intelligent Precision Instrument (3 are a bit unpleasant) you should be familiar with.

Our examination of Shenzhen Intelligent Precision Instrument 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 is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.