Jonjee Hi-Tech Industrial and Commercial HoldingLtd's (SHSE:600872) Profits May Be Overstating Its True Earnings Potential

Following the release of a positive earnings report recently, Jonjee Hi-Tech Industrial and Commercial Holding Co.,Ltd's (SHSE:600872) stock performed well. However, we think that investors should be cautious when interpreting the profit numbers.

See our latest analysis for Jonjee Hi-Tech Industrial and Commercial HoldingLtd

Examining Cashflow Against Jonjee Hi-Tech Industrial and Commercial HoldingLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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 December 2023, Jonjee Hi-Tech Industrial and Commercial HoldingLtd recorded an accrual ratio of 0.42. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of CN¥570m, which is significantly less than its profit of CN¥1.70b. At this point we should mention that Jonjee Hi-Tech Industrial and Commercial HoldingLtd did manage to increase its free cash flow in the last twelve months 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. One positive for Jonjee Hi-Tech Industrial and Commercial HoldingLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥1.1b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. We can see that Jonjee Hi-Tech Industrial and Commercial HoldingLtd's positive unusual items were quite significant relative to its profit in the year to December 2023. 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 Jonjee Hi-Tech Industrial and Commercial HoldingLtd's Profit Performance

Jonjee Hi-Tech Industrial and Commercial HoldingLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. On reflection, the above-mentioned factors give us the strong impression that Jonjee Hi-Tech Industrial and Commercial HoldingLtd'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you want to do dive deeper into Jonjee Hi-Tech Industrial and Commercial HoldingLtd, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Jonjee Hi-Tech Industrial and Commercial HoldingLtd (2 can't be ignored) you should be familiar with.

Our examination of Jonjee Hi-Tech Industrial and Commercial HoldingLtd 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.