Shaky Earnings May Not Tell The Whole Story For Guangdong Feinan Resources Recycling (SZSE:301500)

The recent earnings release from Guangdong Feinan Resources Recycling Co., Ltd (SZSE:301500 ) was disappointing to investors. We think that they may have more to worry about than just soft profit numbers.

Check out our latest analysis for Guangdong Feinan Resources Recycling

A Closer Look At Guangdong Feinan Resources Recycling's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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

Over the twelve months to December 2023, Guangdong Feinan Resources Recycling recorded an accrual ratio of 0.35. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥2.2b, in contrast to the aforementioned profit of CN¥180.1m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥2.2b, this year, indicates high risk. 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 Guangdong Feinan Resources Recycling.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Guangdong Feinan Resources Recycling's profit was boosted by unusual items worth CN¥56m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. If Guangdong Feinan Resources Recycling doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Guangdong Feinan Resources Recycling's Profit Performance

Summing up, Guangdong Feinan Resources Recycling received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Guangdong Feinan Resources Recycling's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Guangdong Feinan Resources Recycling as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 4 warning signs for Guangdong Feinan Resources Recycling and we think they deserve your attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.