Investors Can Find Comfort In Yunnan CopperLtd's (SZSE:000878) Earnings Quality

Soft earnings didn't appear to concern Yunnan Copper Co.,Ltd's (SZSE:000878) shareholders over the last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

Check out our latest analysis for Yunnan CopperLtd

Examining Cashflow Against Yunnan CopperLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Yunnan CopperLtd has an accrual ratio of -0.12 for the year to December 2023. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of CN¥4.8b during the period, dwarfing its reported profit of CN¥1.58b. Yunnan CopperLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Yunnan CopperLtd increased the number of shares on issue by 18% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Yunnan CopperLtd's historical EPS growth by clicking on this link.

How Is Dilution Impacting Yunnan CopperLtd's Earnings Per Share (EPS)?

Yunnan CopperLtd has improved its profit over the last three years, with an annualized gain of 316% in that time. But EPS was only up 253% per year, in the exact same period. Net profit actually dropped by 13% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 24%. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Yunnan CopperLtd's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

Yunnan CopperLtd's profit was reduced by unusual items worth CN¥563m 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, after all, that's exactly what the accounting terminology implies. If Yunnan CopperLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Yunnan CopperLtd's Profit Performance

In conclusion, both Yunnan CopperLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative, but the dilution means that per-share performance is weaker than the statutory profit numbers imply. Looking at all these factors, we'd say that Yunnan CopperLtd's underlying earnings power is at least as good as the statutory numbers would make it seem. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Yunnan CopperLtd.

After our examination into the nature of Yunnan CopperLtd's profit, we've come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.