Chengdu Qushui Science and Technology's (SZSE:301336) Shareholders Have More To Worry About Than Only Soft Earnings

Despite Chengdu Qushui Science and Technology Co., Ltd.'s (SZSE:301336) most recent earnings report having soft headline numbers, its stock has had a positive performance. We looked at the details, and we think that investors may be responding to some encouraging factors.

See our latest analysis for Chengdu Qushui Science and Technology

A Closer Look At Chengdu Qushui Science and Technology'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 March 2024, Chengdu Qushui Science and Technology recorded an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of CN¥41m in the last year, which was a lot more than its statutory profit of CN¥25.2m. Given that Chengdu Qushui Science and Technology had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥41m would seem to be a step in the right direction. 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 Chengdu Qushui Science and Technology.

The Impact Of Unusual Items On Profit

Surprisingly, given Chengdu Qushui Science and Technology's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥2.9m in unusual items. 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'. We can see that Chengdu Qushui Science and Technology's positive unusual items were quite significant relative to its profit in the year to March 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Chengdu Qushui Science and Technology's Profit Performance

Chengdu Qushui Science and Technology's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, we think it's very unlikely that Chengdu Qushui Science and Technology's statutory profits make it seem much weaker than it is. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 3 warning signs for Chengdu Qushui Science and Technology (1 is a bit unpleasant!) that we believe deserve your full attention.

Our examination of Chengdu Qushui Science and Technology has focussed on certain factors that can make its earnings look better than they are. 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.