Guangdong Kitech New Material HoldingLtd's (SZSE:300995) Solid Profits Have Weak Fundamentals

Investors were disappointed with Guangdong Kitech New Material Holding Co.,Ltd.'s (SZSE:300995) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

View our latest analysis for Guangdong Kitech New Material HoldingLtd

Examining Cashflow Against Guangdong Kitech New Material HoldingLtd'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). 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.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Guangdong Kitech New Material HoldingLtd had an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥133m, in contrast to the aforementioned profit of CN¥8.67m. We also note that Guangdong Kitech New Material HoldingLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥133m.

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

Our Take On Guangdong Kitech New Material HoldingLtd's Profit Performance

Guangdong Kitech New Material HoldingLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Guangdong Kitech New Material HoldingLtd's true underlying earnings power is actually less than its statutory profit. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Guangdong Kitech New Material HoldingLtd as a business, it's important to be aware of any risks it's facing. For example - Guangdong Kitech New Material HoldingLtd has 3 warning signs we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Guangdong Kitech New Material HoldingLtd'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. 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 with significant insider holdings 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.