Swancor Advanced Materials' (SHSE:688585) Conservative Accounting Might Explain Soft Earnings

Investors were disappointed with the weak earnings posted by Swancor Advanced Materials Co., Ltd. (SHSE:688585 ). However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

See our latest analysis for Swancor Advanced Materials

A Closer Look At Swancor Advanced Materials' 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 December 2023, Swancor Advanced Materials had an accrual ratio of -0.24. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥308m, well over the CN¥70.9m it reported in profit. Given that Swancor Advanced Materials had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥308m would seem to be a step in the right direction.

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

Our Take On Swancor Advanced Materials' Profit Performance

As we discussed above, Swancor Advanced Materials' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Swancor Advanced Materials' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 1 warning sign for Swancor Advanced Materials you should know about.

Today we've zoomed in on a single data point to better understand the nature of Swancor Advanced Materials' profit. But there are plenty of other ways to inform your opinion of a company. 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 that insiders are buying 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.