There May Be Underlying Issues With The Quality Of Wuzhou Special Paper Group's (SHSE:605007) Earnings

Wuzhou Special Paper Group Co., Ltd. (SHSE:605007) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for Wuzhou Special Paper Group

Zooming In On Wuzhou Special Paper Group's 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 September 2024, Wuzhou Special Paper Group had an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of CN¥1.7b, in contrast to the aforementioned profit of CN¥492.9m. We also note that Wuzhou Special Paper Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.7b.

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.

Our Take On Wuzhou Special Paper Group's Profit Performance

As we have made quite clear, we're a bit worried that Wuzhou Special Paper Group didn't back up the last year's profit with free cashflow. For this reason, we think that Wuzhou Special Paper Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. 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 want to do dive deeper into Wuzhou Special Paper Group, you'd also look into what risks it is currently facing. To that end, you should learn about the 3 warning signs we've spotted with Wuzhou Special Paper Group (including 2 which make us uncomfortable).

This note has only looked at a single factor that sheds light on the nature of Wuzhou Special Paper Group's profit. But there are plenty of other ways to inform your opinion of a company. 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 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.