Jiangxi Zhengbang TechnologyLtd's (SZSE:002157) Shareholders May Want To Dig Deeper Than Statutory Profit

Jiangxi Zhengbang Technology Co.Ltd.'s (SZSE:002157) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

Check out our latest analysis for Jiangxi Zhengbang TechnologyLtd

Examining Cashflow Against Jiangxi Zhengbang TechnologyLtd'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. The ratio shows us how much a company's profit exceeds its FCF.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Jiangxi Zhengbang TechnologyLtd has an accrual ratio of 2.43 for the year to March 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥2.0b, in contrast to the aforementioned profit of CN¥9.66b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥2.0b, this year, indicates high risk. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. The good news for shareholders is that Jiangxi Zhengbang TechnologyLtd'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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jiangxi Zhengbang TechnologyLtd.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Jiangxi Zhengbang TechnologyLtd issued 199% more new shares over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Jiangxi Zhengbang TechnologyLtd's EPS by clicking here.

How Is Dilution Impacting Jiangxi Zhengbang TechnologyLtd's Earnings Per Share (EPS)?

As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Jiangxi Zhengbang TechnologyLtd's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Jiangxi Zhengbang TechnologyLtd saw its profit reduced by unusual items worth CN¥1.3b. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. 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. In the twelve months to March 2024, Jiangxi Zhengbang TechnologyLtd had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Jiangxi Zhengbang TechnologyLtd's Profit Performance

Summing up, Jiangxi Zhengbang TechnologyLtd's unusual items suggest that its statutory earnings were temporarily depressed, and its accrual ratio indicates a lack of free cash flow relative to profit. And the dilution means that per-share results are weaker than the bottom line might imply. For the reasons mentioned above, we think that a perfunctory glance at Jiangxi Zhengbang TechnologyLtd's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Jiangxi Zhengbang TechnologyLtd as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 2 warning signs for Jiangxi Zhengbang TechnologyLtd and you'll want to know about them.

Our examination of Jiangxi Zhengbang TechnologyLtd 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 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 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.