Earnings Troubles May Signal Larger Issues for Zhejiang Entive Smart Kitchen Appliance (SZSE:300911) Shareholders

A lackluster earnings announcement from Zhejiang Entive Smart Kitchen Appliance Co., Ltd. (SZSE:300911) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Zhejiang Entive Smart Kitchen Appliance

Examining Cashflow Against Zhejiang Entive Smart Kitchen Appliance's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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'.

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.

For the year to March 2024, Zhejiang Entive Smart Kitchen Appliance had an accrual ratio of 0.31. 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. In fact, it had free cash flow of CN¥3.7m in the last year, which was a lot less than its statutory profit of CN¥142.9m. Given that Zhejiang Entive Smart Kitchen Appliance had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥3.7m would seem to be a step in the right direction. Having said that, there is more to the story. 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?

The fact that the company had unusual items boosting profit by CN¥12m, 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. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Zhejiang Entive Smart Kitchen Appliance 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 Zhejiang Entive Smart Kitchen Appliance's Profit Performance

Zhejiang Entive Smart Kitchen Appliance had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Zhejiang Entive Smart Kitchen Appliance's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Zhejiang Entive Smart Kitchen Appliance, you'd also look into what risks it is currently facing. For example, Zhejiang Entive Smart Kitchen Appliance has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

Our examination of Zhejiang Entive Smart Kitchen Appliance 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 is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.