We Believe That Shaanxi Huaqin Technology IndustryLtd's (SHSE:688281) Weak Earnings Are A Good Indicator Of Underlying Profitability

Shaanxi Huaqin Technology Industry Co.,Ltd.'s (SHSE:688281) stock wasn't much affected by its recent lackluster earnings numbers. We did some analysis and found some concerning details beneath the statutory profit number.

See our latest analysis for Shaanxi Huaqin Technology IndustryLtd

Zooming In On Shaanxi Huaqin Technology IndustryLtd'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Shaanxi Huaqin Technology IndustryLtd 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. Even though it reported a profit of CN¥374.0m, a look at free cash flow indicates it actually burnt through CN¥344m in the last year. We also note that Shaanxi Huaqin Technology IndustryLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥344m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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 Shaanxi Huaqin Technology IndustryLtd's profit was boosted by unusual items worth CN¥30m 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 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. Which is hardly surprising, given the name. If Shaanxi Huaqin Technology IndustryLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Shaanxi Huaqin Technology IndustryLtd's Profit Performance

Shaanxi Huaqin Technology IndustryLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shaanxi Huaqin Technology IndustryLtd's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Shaanxi Huaqin Technology IndustryLtd has 2 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.