Dongguan Golden Sun AbrasivesLtd's (SZSE:300606) Solid Profits Have Weak Fundamentals

Dongguan Golden Sun Abrasives Co.,Ltd's (SZSE:300606) stock was strong after they recently reported robust earnings. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out our latest analysis for Dongguan Golden Sun AbrasivesLtd

Examining Cashflow Against Dongguan Golden Sun AbrasivesLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2024, Dongguan Golden Sun AbrasivesLtd recorded an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥60.5m, a look at free cash flow indicates it actually burnt through CN¥85m in the last year. We also note that Dongguan Golden Sun AbrasivesLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥85m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dongguan Golden Sun AbrasivesLtd.

Our Take On Dongguan Golden Sun AbrasivesLtd's Profit Performance

Dongguan Golden Sun AbrasivesLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Dongguan Golden Sun AbrasivesLtd's true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Dongguan Golden Sun AbrasivesLtd at this point in time. Be aware that Dongguan Golden Sun AbrasivesLtd is showing 4 warning signs in our investment analysis and 3 of those are concerning...

This note has only looked at a single factor that sheds light on the nature of Dongguan Golden Sun AbrasivesLtd's profit. But there are plenty of other ways to inform your opinion of a company. 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 with high insider ownership.

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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.