Wanxiang Doneed's (SHSE:600371) Problems Go Beyond Poor Profit

Investors were disappointed with Wanxiang Doneed Co., ltd's (SHSE:600371) recent earnings. We think there is more to the story than simply soft profit numbers. Our analysis shows that there are some other factors of concern.

View our latest analysis for Wanxiang Doneed

A Closer Look At Wanxiang Doneed's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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. 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 September 2024, Wanxiang Doneed recorded an accrual ratio of 0.64. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥45m despite its profit of CN¥65.7m, mentioned above. It's worth noting that Wanxiang Doneed generated positive FCF of CN¥19m a year ago, so at least they've done it in the past. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wanxiang Doneed.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥5.1m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Wanxiang Doneed's Profit Performance

Wanxiang Doneed had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Wanxiang Doneed's statutory profits might make it look better than it really is on an underlying level. 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. In terms of investment risks, we've identified 2 warning signs with Wanxiang Doneed, and understanding these bad boys should be part of your investment process.

Our examination of Wanxiang Doneed 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. 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.