Guangzhou Lushan New Materials' (SHSE:603051) Solid Earnings May Rest On Weak Foundations

The recent earnings posted by Guangzhou Lushan New Materials Co., Ltd. (SHSE:603051) were solid, but the stock didn't move as much as we expected. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Guangzhou Lushan New Materials

The Impact Of Unusual Items On Profit

Importantly, our data indicates that Guangzhou Lushan New Materials' profit received a boost of CN¥7.9m in unusual items, over the last year. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. 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).

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangzhou Lushan New Materials.

An Unusual Tax Situation

Having already discussed the impact of the unusual items, we should also note that Guangzhou Lushan New Materials received a tax benefit of CN¥5.3m. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. We're sure the company was pleased with its tax benefit. And given that it lost money last year, it seems possible that the benefit is evidence that it now expects to find value in its past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Guangzhou Lushan New Materials' Profit Performance

In the last year Guangzhou Lushan New Materials received a tax benefit, which boosted its profit in a way that might not be much more sustainable than turning prime farmland into gas fields. Furthermore, it also benefitted from a positive unusual item, which boosted the profit result even higher. Considering all this we'd argue Guangzhou Lushan New Materials' profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 4 warning signs (2 are potentially serious!) that you ought to be aware of before buying any shares in Guangzhou Lushan New Materials.

Our examination of Guangzhou Lushan New Materials 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.