There May Be Underlying Issues With The Quality Of Shengtak New Material's (SZSE:300881) Earnings

Despite announcing strong earnings, Shengtak New Material Co., Ltd's (SZSE:300881) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for Shengtak New Material

Zooming In On Shengtak New Material'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 March 2024, Shengtak New Material had an accrual ratio of 0.45. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥327m despite its profit of CN¥150.2m, mentioned above. We also note that Shengtak New Material's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥327m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shengtak New Material.

Our Take On Shengtak New Material's Profit Performance

As we discussed above, we think Shengtak New Material's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Shengtak New Material's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Shengtak New Material as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for Shengtak New Material (1 is concerning) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Shengtak New Material's profit. 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.