Why Tongqinglou Catering's (SHSE:605108) Earnings Are Weaker Than They Seem

Despite posting strong earnings, Tongqinglou Catering Co., Ltd.'s (SHSE:605108) stock didn't move much over the last week. We decided to have a deeper look, and we believe that investors might be worried about several concerning factors that we found.

Check out our latest analysis for Tongqinglou Catering

Zooming In On Tongqinglou Catering'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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, Tongqinglou Catering had an accrual ratio of 0.52. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥873m despite its profit of CN¥297.7m, mentioned above. We also note that Tongqinglou Catering's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥873m. 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?

Given the accrual ratio, it's not overly surprising that Tongqinglou Catering's profit was boosted by unusual items worth CN¥39m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Tongqinglou Catering 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 Tongqinglou Catering's Profit Performance

Summing up, Tongqinglou Catering 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 Tongqinglou Catering's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 1 warning sign for Tongqinglou Catering you should know about.

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 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. 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.