Zhejiang Zhongke Magnetic Industry's (SZSE:301141) Problems Go Beyond Poor Profit

Zhejiang Zhongke Magnetic Industry Co., Ltd. (SZSE:301141) recently posted soft earnings but shareholders didn't react strongly. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

See our latest analysis for Zhejiang Zhongke Magnetic Industry

Examining Cashflow Against Zhejiang Zhongke Magnetic Industry'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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. 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, Zhejiang Zhongke Magnetic Industry recorded an accrual ratio of 0.54. Statistically speaking, that's a real negative for future earnings. 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¥214m, in contrast to the aforementioned profit of CN¥27.5m. It's worth noting that Zhejiang Zhongke Magnetic Industry generated positive FCF of CN¥198m a year ago, so at least they've done it 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 Zhejiang Zhongke Magnetic Industry'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 Zhejiang Zhongke Magnetic Industry.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥2.7m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Zhejiang Zhongke Magnetic Industry's positive unusual items were quite significant relative to its profit in the year to June 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Zhejiang Zhongke Magnetic Industry's Profit Performance

Zhejiang Zhongke Magnetic Industry had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Zhejiang Zhongke Magnetic Industry's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Zhejiang Zhongke Magnetic Industry, you'd also look into what risks it is currently facing. Our analysis shows 5 warning signs for Zhejiang Zhongke Magnetic Industry (3 are a bit concerning!) and we strongly recommend you look at these bad boys before investing.

Our examination of Zhejiang Zhongke Magnetic Industry 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 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 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.