Weak Statutory Earnings May Not Tell The Whole Story For Tofflon Science and Technology Group (SZSE:300171)

Tofflon Science and Technology Group Co., Ltd.'s (SZSE:300171) stock showed strength, with investors undeterred by its weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Tofflon Science and Technology Group.

Check out our latest analysis for Tofflon Science and Technology Group

Zooming In On Tofflon Science and Technology Group'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2024, Tofflon Science and Technology Group had an accrual ratio of 0.32. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥864m despite its profit of CN¥433.9m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥864m, this year, indicates high risk. 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.

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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Tofflon Science and Technology Group's profit was boosted by unusual items worth CN¥72m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. 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 Tofflon Science and Technology Group's Profit Performance

Summing up, Tofflon Science and Technology Group received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Tofflon Science and Technology Group's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Tofflon Science and Technology Group at this point in time. When we did our research, we found 3 warning signs for Tofflon Science and Technology Group (1 is concerning!) that we believe deserve your full attention.

Our examination of Tofflon Science and Technology Group 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. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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.