YCIC Eco-TechnologyLtd's (SZSE:002200) Soft Earnings Don't Show The Whole Picture

The market for YCIC Eco-Technology Co.,Ltd.'s (SZSE:002200) shares didn't move much after it posted weak earnings recently. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

See our latest analysis for YCIC Eco-TechnologyLtd

Zooming In On YCIC Eco-TechnologyLtd'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

YCIC Eco-TechnologyLtd has an accrual ratio of -0.31 for the year to March 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥392m during the period, dwarfing its reported profit of CN¥11.1m. Given that YCIC Eco-TechnologyLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥392m would seem to be a step in the right direction. 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 YCIC Eco-TechnologyLtd.

The Impact Of Unusual Items On Profit

YCIC Eco-TechnologyLtd's profit was reduced by unusual items worth CN¥4.8m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. 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, after all, that's exactly what the accounting terminology implies. YCIC Eco-TechnologyLtd took a rather significant hit from unusual items in the year to March 2024. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On YCIC Eco-TechnologyLtd's Profit Performance

In conclusion, both YCIC Eco-TechnologyLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think YCIC Eco-TechnologyLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! So while earnings quality is important, it's equally important to consider the risks facing YCIC Eco-TechnologyLtd at this point in time. Every company has risks, and we've spotted 3 warning signs for YCIC Eco-TechnologyLtd you should know about.

Our examination of YCIC Eco-TechnologyLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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.