Innuovo Technology's (SZSE:000795) Soft Earnings Are Actually Better Than They Appear

Innuovo Technology Co., Ltd.'s (SZSE:000795) stock was strong despite it releasing a soft earnings report last week. We think that investors might be looking at some positive factors beyond the earnings numbers.

View our latest analysis for Innuovo Technology

Examining Cashflow Against Innuovo Technology'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. 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. 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.

Innuovo Technology has an accrual ratio of -0.11 for the year to December 2023. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥338m, well over the CN¥86.7m it reported in profit. Notably, Innuovo Technology had negative free cash flow last year, so the CN¥338m it produced this year was a welcome improvement. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Innuovo Technology.

The Impact Of Unusual Items On Profit

Innuovo Technology's profit was reduced by unusual items worth CN¥30m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Innuovo Technology to produce a higher profit next year, all else being equal.

Our Take On Innuovo Technology's Profit Performance

In conclusion, both Innuovo Technology's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that Innuovo Technology's underlying earnings power is at least as good as the statutory numbers would make it seem. If you want to do dive deeper into Innuovo Technology, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 2 warning signs with Innuovo Technology, and understanding them should be part of your investment process.

Our examination of Innuovo Technology has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.