Why Jiangsu Lidao New Materials' (SHSE:603937) Shaky Earnings Are Just The Beginning Of Its Problems

The market rallied behind Jiangsu Lidao New Materials Co., Ltd.'s (SHSE:603937) stock, leading do a rise in the share price after its recent weak earnings report. We think that shareholders might be missing some concerning factors that our analysis found.

View our latest analysis for Jiangsu Lidao New Materials

Examining Cashflow Against Jiangsu Lidao New Materials' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Jiangsu Lidao New Materials recorded an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥262m, in contrast to the aforementioned profit of CN¥67.4m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥262m, this year, indicates high risk.

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

Our Take On Jiangsu Lidao New Materials' Profit Performance

Jiangsu Lidao New Materials' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Jiangsu Lidao New Materials' true underlying earnings power is actually less than its statutory profit. Sadly, its EPS was down over the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Jiangsu Lidao New Materials as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 3 warning signs (2 are a bit unpleasant!) that you ought to be aware of before buying any shares in Jiangsu Lidao New Materials.

This note has only looked at a single factor that sheds light on the nature of Jiangsu Lidao New Materials' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.