Ningbo David Medical Device's (SZSE:300314) Shareholders Have More To Worry About Than Only Soft Earnings

Ningbo David Medical Device Co., Ltd.'s (SZSE:300314) stock showed strength, with investors undeterred by its weak earnings report. We think that shareholders might be missing some concerning factors that our analysis found.

See our latest analysis for Ningbo David Medical Device

A Closer Look At Ningbo David Medical Device'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. 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. 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. 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. 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 September 2024, Ningbo David Medical Device had an accrual ratio of 0.30. 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. Even though it reported a profit of CN¥88.1m, a look at free cash flow indicates it actually burnt through CN¥49m in the last year. It's worth noting that Ningbo David Medical Device generated positive FCF of CN¥107m 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.

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¥9.2m, 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 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. If Ningbo David Medical Device doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Ningbo David Medical Device's Profit Performance

Ningbo David Medical Device 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 Ningbo David Medical Device's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Ningbo David Medical Device as a business, it's important to be aware of any risks it's facing. For instance, we've identified 4 warning signs for Ningbo David Medical Device (1 is concerning) you should be familiar with.

Our examination of Ningbo David Medical Device 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. 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.