Shanghai Titan Scientific's (SHSE:688133) Sluggish Earnings Might Be Just The Beginning Of Its Problems

A lackluster earnings announcement from Shanghai Titan Scientific Co., Ltd. (SHSE:688133) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Shanghai Titan Scientific

Examining Cashflow Against Shanghai Titan Scientific'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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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 June 2024, Shanghai Titan Scientific had an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥27.2m, a look at free cash flow indicates it actually burnt through CN¥613m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥613m, this year, indicates high risk. 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?

Given the accrual ratio, it's not overly surprising that Shanghai Titan Scientific's profit was boosted by unusual items worth CN¥15m in the last twelve months. 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. Which is hardly surprising, given the name. We can see that Shanghai Titan Scientific's positive unusual items were quite significant relative to its profit in the year to June 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Shanghai Titan Scientific's Profit Performance

Shanghai Titan Scientific had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shanghai Titan Scientific's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Shanghai Titan Scientific, you'd also look into what risks it is currently facing. To help with this, we've discovered 2 warning signs (1 is potentially serious!) that you ought to be aware of before buying any shares in Shanghai Titan Scientific.

Our examination of Shanghai Titan Scientific 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. 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.