Anhui Xinbo Aluminum's (SZSE:003038) Earnings Are Built On Soft Foundations

Anhui Xinbo Aluminum Co., Ltd.'s (SZSE:003038) solid earnings report last week was underwhelming to investors. We did some digging and found some worrying factors that they might be paying attention to.

Check out our latest analysis for Anhui Xinbo Aluminum

Zooming In On Anhui Xinbo Aluminum'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. 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. 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.

Over the twelve months to December 2023, Anhui Xinbo Aluminum recorded an accrual ratio of 0.45. 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. Over the last year it actually had negative free cash flow of CN¥1.6b, in contrast to the aforementioned profit of CN¥302.4m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥1.6b, 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. Anhui Xinbo Aluminum expanded the number of shares on issue by 21% over the last year. As a result, its net income is now split between 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. You can see a chart of Anhui Xinbo Aluminum's EPS by clicking here.

How Is Dilution Impacting Anhui Xinbo Aluminum's Earnings Per Share (EPS)?

Anhui Xinbo Aluminum has improved its profit over the last three years, with an annualized gain of 232% in that time. But EPS was only up 119% per year, in the exact same period. And at a glance the 61% gain in profit over the last year impresses. On the other hand, earnings per share are only up 53% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Anhui Xinbo Aluminum 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 Anhui Xinbo Aluminum's Profit Performance

As it turns out, Anhui Xinbo Aluminum couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Anhui Xinbo Aluminum's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Anhui Xinbo Aluminum is showing 4 warning signs in our investment analysis and 2 of those don't sit too well with us...

Our examination of Anhui Xinbo Aluminum 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 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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.