China National Gold Group Gold JewelleryLtd's (SHSE:600916) Solid Earnings Have Been Accounted For Conservatively

Investors signalled that they were pleased with China National Gold Group Gold Jewellery Co.,Ltd.'s (SHSE:600916) most recent earnings report. Looking deeper at the numbers, we found several encouraging factors beyond the headline profit numbers.

See our latest analysis for China National Gold Group Gold JewelleryLtd

Zooming In On China National Gold Group Gold JewelleryLtd'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). 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, China National Gold Group Gold JewelleryLtd recorded an accrual ratio of -1.36. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥3.8b during the period, dwarfing its reported profit of CN¥1.04b. China National Gold Group Gold JewelleryLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

China National Gold Group Gold JewelleryLtd's profit was reduced by unusual items worth CN¥416m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. 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. If China National Gold Group Gold JewelleryLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On China National Gold Group Gold JewelleryLtd's Profit Performance

In conclusion, both China National Gold Group Gold JewelleryLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think China National Gold Group Gold JewelleryLtd'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 China National Gold Group Gold JewelleryLtd at this point in time. While conducting our analysis, we found that China National Gold Group Gold JewelleryLtd has 2 warning signs and it would be unwise to ignore them.

Our examination of China National Gold Group Gold JewelleryLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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.

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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.