Why Guangdong Yussen Energy Technology's (SZSE:002986) Healthy Earnings Aren’t As Good As They Seem

Investors appear disappointed with Guangdong Yussen Energy Technology Co., Ltd.'s (SZSE:002986) recent earnings, despite the decent statutory profit number. Our analysis has found some underlying factors which may be cause for concern.

Check out our latest analysis for Guangdong Yussen Energy Technology

Zooming In On 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2023, Guangdong Yussen Energy Technology recorded an accrual ratio of 0.36. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥453.8m, a look at free cash flow indicates it actually burnt through CN¥570m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥570m, this year, indicates high risk. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. 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 talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Guangdong Yussen Energy Technology's historical EPS growth by clicking on this link.

How Is Dilution Impacting Guangdong Yussen Energy Technology's Earnings Per Share (EPS)?

As you can see above, Guangdong Yussen Energy Technology has been growing its net income over the last few years, with an annualized gain of 1,281% over three years. In comparison, earnings per share only gained 1,136% over the same period. And in the last year the company managed to bump profit up by 5.4%. On the other hand, earnings per share are only up 4.7% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Guangdong Yussen Energy Technology can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

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 its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at Guangdong Yussen Energy Technology's statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've found that Guangdong Yussen Energy Technology has 3 warning signs (1 makes us a bit uncomfortable!) that deserve your attention before going any further with your analysis.

Our examination of Guangdong Yussen Energy Technology has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.