There Are Some Reasons To Suggest That Bear Electric ApplianceLtd's (SZSE:002959) Earnings Are A Poor Reflection Of Profitability

Solid profit numbers didn't seem to be enough to please Bear Electric Appliance Co.,Ltd.'s (SZSE:002959) shareholders. Our analysis suggests they may be concerned about some underlying details.

Check out our latest analysis for Bear Electric ApplianceLtd

Examining Cashflow Against Bear Electric ApplianceLtd'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 December 2023, Bear Electric ApplianceLtd recorded an accrual ratio of 0.91. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of CN¥260m during the period, falling well short of its reported profit of CN¥445.3m. Bear Electric ApplianceLtd shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. 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.

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?

The fact that the company had unusual items boosting profit by CN¥52m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Bear Electric ApplianceLtd 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 Bear Electric ApplianceLtd's Profit Performance

Bear Electric ApplianceLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Bear Electric ApplianceLtd's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Bear Electric ApplianceLtd is showing 2 warning signs in our investment analysis and 1 of those is significant...

Our examination of Bear Electric ApplianceLtd 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 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.