We Think Guangdong Silver Age Sci & TechLtd's (SZSE:300221) Solid Earnings Are Understated

The market seemed underwhelmed by the solid earnings posted by Guangdong Silver Age Sci & Tech Co.,Ltd. (SZSE:300221) recently. Our analysis suggests that there are some reasons for hope that investors should be aware of.

View our latest analysis for Guangdong Silver Age Sci & TechLtd

Zooming In On Guangdong Silver Age Sci & TechLtd'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. 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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to December 2023, Guangdong Silver Age Sci & TechLtd had an accrual ratio of 0.21. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥27.0m, a look at free cash flow indicates it actually burnt through CN¥222m in the last year. We saw that FCF was CN¥203m a year ago though, so Guangdong Silver Age Sci & TechLtd has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. The good news for shareholders is that Guangdong Silver Age Sci & TechLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangdong Silver Age Sci & TechLtd.

How Do Unusual Items Influence Profit?

Guangdong Silver Age Sci & TechLtd's profit suffered from unusual items, which reduced profit by CN¥18m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Guangdong Silver Age Sci & TechLtd 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 Guangdong Silver Age Sci & TechLtd's Profit Performance

Guangdong Silver Age Sci & TechLtd saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Considering all the aforementioned, we'd venture that Guangdong Silver Age Sci & TechLtd's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into Guangdong Silver Age Sci & TechLtd, you'd also look into what risks it is currently facing. For example, we've found that Guangdong Silver Age Sci & TechLtd has 2 warning signs (1 can't be ignored!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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.

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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.