Guangdong Yussen Energy Technology (SZSE:002986) Posted Weak Earnings But There Is More To Worry About

Investors were disappointed with Guangdong Yussen Energy Technology Co., Ltd.'s (SZSE:002986) recent earnings. We think there is more to the story than simply soft profit numbers. Our analysis shows that there are some other factors of concern.

See our latest analysis for Guangdong Yussen Energy Technology

A Closer Look At Guangdong Yussen Energy Technology's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Guangdong Yussen Energy Technology recorded an accrual ratio of 0.42. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥334.1m, a look at free cash flow indicates it actually burnt through CN¥1.6b in the last year. We also note that Guangdong Yussen Energy Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.6b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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, Guangdong Yussen Energy Technology increased the number of shares on issue by 20% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. 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 Guangdong Yussen Energy Technology's historical EPS growth by clicking on this link.

A Look At The Impact Of Guangdong Yussen Energy Technology's Dilution On Its Earnings Per Share (EPS)

Guangdong Yussen Energy Technology has improved its profit over the last three years, with an annualized gain of 178% in that time. In comparison, earnings per share only gained 127% over the same period. Net profit actually dropped by 30% in the last year. But the EPS result was even worse, with the company recording a decline of 39%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Guangdong Yussen Energy Technology's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Guangdong Yussen Energy Technology's Profit Performance

In conclusion, Guangdong Yussen Energy Technology has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). Considering all this we'd argue Guangdong Yussen Energy Technology's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 4 warning signs for Guangdong Yussen Energy Technology (1 shouldn't be ignored) you should be familiar with.

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 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 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.