Longyan Zhuoyue New Energy's (SHSE:688196) Weak Earnings May Only Reveal A Part Of The Whole Picture

Last week's earnings announcement from Longyan Zhuoyue New Energy Co., Ltd. (SHSE:688196) was disappointing to investors, with a sluggish profit figure. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

Check out our latest analysis for Longyan Zhuoyue New Energy

Zooming In On Longyan Zhuoyue New Energy'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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 September 2024, Longyan Zhuoyue New Energy recorded an accrual ratio of 0.21. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥524m despite its profit of CN¥17.9m, mentioned above. It's worth noting that Longyan Zhuoyue New Energy generated positive FCF of CN¥208m a year ago, so at least they've done it in the past. The good news for shareholders is that Longyan Zhuoyue New Energy's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

Our Take On Longyan Zhuoyue New Energy's Profit Performance

Longyan Zhuoyue New Energy's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Longyan Zhuoyue New Energy's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Longyan Zhuoyue New Energy at this point in time. Every company has risks, and we've spotted 3 warning signs for Longyan Zhuoyue New Energy (of which 2 make us uncomfortable!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Longyan Zhuoyue New Energy's profit. 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 with significant insider holdings 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.