Shaky Earnings May Not Tell The Whole Story For MEGA P&C Advanced Materials (Shanghai) (SHSE:603062)

Shareholders didn't appear too concerned by MEGA P&C Advanced Materials (Shanghai) Company Limited's (SHSE:603062) weak earnings. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

See our latest analysis for MEGA P&C Advanced Materials (Shanghai)

Zooming In On MEGA P&C Advanced Materials (Shanghai)'s Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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.

For the year to March 2024, MEGA P&C Advanced Materials (Shanghai) had an accrual ratio of 0.38. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥126m despite its profit of CN¥138.9m, mentioned above. It's worth noting that MEGA P&C Advanced Materials (Shanghai) generated positive FCF of CN¥218m 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?

On top of the noteworthy accrual ratio and the spike in non-operating revenue, we can also see that MEGA P&C Advanced Materials (Shanghai) benefitted from unusual items worth CN¥33m 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. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. MEGA P&C Advanced Materials (Shanghai) had a rather significant contribution from unusual items relative to its profit to March 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On MEGA P&C Advanced Materials (Shanghai)'s Profit Performance

Summing up, MEGA P&C Advanced Materials (Shanghai) 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 MEGA P&C Advanced Materials (Shanghai)'s profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about MEGA P&C Advanced Materials (Shanghai) as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for MEGA P&C Advanced Materials (Shanghai) (2 are a bit concerning!) that we believe deserve your full attention.

Our examination of MEGA P&C Advanced Materials (Shanghai) 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 that insiders are buying.

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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.