Shareholders Can Be Confident That Suzhou Electrical Apparatus Science Academy's (SZSE:300215) Earnings Are High Quality

Suzhou Electrical Apparatus Science Academy Co., Ltd. (SZSE:300215) recently posted some strong earnings, and the market responded positively. Our analysis found some more factors that we think are good for shareholders.

Check out our latest analysis for Suzhou Electrical Apparatus Science Academy

A Closer Look At Suzhou Electrical Apparatus Science Academy's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, Suzhou Electrical Apparatus Science Academy recorded an accrual ratio of -0.16. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥405m during the period, dwarfing its reported profit of CN¥31.4m. Suzhou Electrical Apparatus Science Academy's free cash flow improved over the last year, which is generally good to see. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Suzhou Electrical Apparatus Science Academy.

The Impact Of Unusual Items On Profit

Suzhou Electrical Apparatus Science Academy's profit was reduced by unusual items worth CN¥10m 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Suzhou Electrical Apparatus Science Academy to produce a higher profit next year, all else being equal.

Our Take On Suzhou Electrical Apparatus Science Academy's Profit Performance

Considering both Suzhou Electrical Apparatus Science Academy's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Looking at all these factors, we'd say that Suzhou Electrical Apparatus Science Academy's underlying earnings power is at least as good as the statutory numbers would make it seem. So while earnings quality is important, it's equally important to consider the risks facing Suzhou Electrical Apparatus Science Academy at this point in time. For example, Suzhou Electrical Apparatus Science Academy has 2 warning signs (and 1 which is significant) we think you should know about.

Our examination of Suzhou Electrical Apparatus Science Academy 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. 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.