Shenzhen SEGLtd's (SZSE:000058) Promising Earnings May Rest On Soft Foundations

Shenzhen SEG Co.,Ltd (SZSE:000058) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

View our latest analysis for Shenzhen SEGLtd

A Closer Look At Shenzhen SEGLtd'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. 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. 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. 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.

Over the twelve months to December 2023, Shenzhen SEGLtd recorded an accrual ratio of -0.13. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of CN¥362m in the last year, which was a lot more than its statutory profit of CN¥90.5m. Shenzhen SEGLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen SEGLtd.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Shenzhen SEGLtd's profit was boosted by unusual items worth CN¥88m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. We can see that Shenzhen SEGLtd's positive unusual items were quite significant relative to its profit in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Shenzhen SEGLtd's Profit Performance

Shenzhen SEGLtd's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Having considered these factors, we don't think Shenzhen SEGLtd's statutory profits give an overly harsh view of the business. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Every company has risks, and we've spotted 1 warning sign for Shenzhen SEGLtd you should know about.

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. Some people consider a high return on equity to be a good sign of a quality business. 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.