We Think You Can Look Beyond Xiamen Jihong Technology's (SZSE:002803) Lackluster Earnings

Xiamen Jihong Technology Co., Ltd.'s (SZSE:002803) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. We think that investors might be looking at some positive factors beyond the earnings numbers.

Check out our latest analysis for Xiamen Jihong Technology

Zooming In On Xiamen Jihong Technology'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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Xiamen Jihong Technology has an accrual ratio of -0.16 for the year to September 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥424m in the last year, which was a lot more than its statutory profit of CN¥156.2m. Xiamen Jihong Technology shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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.

How Do Unusual Items Influence Profit?

Surprisingly, given Xiamen Jihong Technology's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥41m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Xiamen Jihong 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 Xiamen Jihong Technology's Profit Performance

In conclusion, Xiamen Jihong Technology's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don't have a strong view as to whether Xiamen Jihong Technology's profits are an apt reflection of its underlying potential for profit. If you want to do dive deeper into Xiamen Jihong Technology, you'd also look into what risks it is currently facing. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Xiamen Jihong Technology.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 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.