Weima Agricultural MachineryLtd (SZSE:301533) Posted Weak Earnings But There Is More To Worry About

Investors were disappointed with Weima Agricultural Machinery Co.,Ltd.'s (SZSE:301533) recent earnings. We looked deeper and believe that there is even more to be worried about, beyond the soft profit numbers.

Check out our latest analysis for Weima Agricultural MachineryLtd

Zooming In On Weima Agricultural MachineryLtd'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Weima Agricultural MachineryLtd has an accrual ratio of 0.59 for the year to September 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥69m, in contrast to the aforementioned profit of CN¥78.0m. It's worth noting that Weima Agricultural MachineryLtd generated positive FCF of CN¥90m a year ago, so at least they've done it in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Weima Agricultural MachineryLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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 Weima Agricultural MachineryLtd.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Weima Agricultural MachineryLtd's profit was boosted by unusual items worth CN¥6.1m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. And, after all, that's exactly what the accounting terminology implies. 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 Weima Agricultural MachineryLtd's Profit Performance

Weima Agricultural MachineryLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Weima Agricultural MachineryLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Weima Agricultural MachineryLtd, you'd also look into what risks it is currently facing. For example, Weima Agricultural MachineryLtd has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

Our examination of Weima Agricultural MachineryLtd 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 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 with significant insider holdings 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.