Additional Considerations Required While Assessing Shanghai Fengyuzhu Culture Technology's (SHSE:603466) Strong Earnings

Last week's profit announcement from Shanghai Fengyuzhu Culture Technology Co., Ltd. (SHSE:603466) was underwhelming for investors, despite headline numbers being robust. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

View our latest analysis for Shanghai Fengyuzhu Culture Technology

Zooming In On Shanghai Fengyuzhu Culture Technology'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Shanghai Fengyuzhu Culture Technology has an accrual ratio of 0.23 for the year to March 2024. 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¥223.2m, a look at free cash flow indicates it actually burnt through CN¥17m in the last year. It's worth noting that Shanghai Fengyuzhu Culture Technology generated positive FCF of CN¥323m a year ago, so at least they've done it in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that Shanghai Fengyuzhu Culture Technology'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.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Shanghai Fengyuzhu Culture Technology's profit was boosted by unusual items worth CN¥51m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Shanghai Fengyuzhu Culture Technology doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Shanghai Fengyuzhu Culture Technology's Profit Performance

Shanghai Fengyuzhu Culture Technology had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shanghai Fengyuzhu Culture Technology's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. At Simply Wall St, we found 1 warning sign for Shanghai Fengyuzhu Culture Technology and we think they deserve your attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying 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.