Daodaoquan Grain and OilLtd's (SZSE:002852) Solid Earnings Have Been Accounted For Conservatively

Shareholders appeared to be happy with Daodaoquan Grain and Oil Co.,Ltd.'s (SZSE:002852) solid earnings report last week. Looking deeper at the numbers, we found several encouraging factors beyond the headline profit numbers.

See our latest analysis for Daodaoquan Grain and OilLtd

Zooming In On Daodaoquan Grain and OilLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, Daodaoquan Grain and OilLtd recorded an accrual ratio of -1.13. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥3.8b during the period, dwarfing its reported profit of CN¥41.7m. Daodaoquan Grain and OilLtd's free cash flow improved over the last year, which is generally good to see. 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 Daodaoquan Grain and OilLtd.

How Do Unusual Items Influence Profit?

Daodaoquan Grain and OilLtd's profit was reduced by unusual items worth CN¥105m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Daodaoquan Grain and OilLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Daodaoquan Grain and OilLtd's Profit Performance

In conclusion, both Daodaoquan Grain and OilLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Daodaoquan Grain and OilLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into Daodaoquan Grain and OilLtd, you'd also look into what risks it is currently facing. Case in point: We've spotted 4 warning signs for Daodaoquan Grain and OilLtd you should be mindful of and 1 of these is potentially serious.

Our examination of Daodaoquan Grain and OilLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.