Nexchip Semiconductor's (SHSE:688249) Weak Earnings Might Be Worse Than They Appear

After announcing weak earnings, Nexchip Semiconductor Corporation's (SHSE:688249) stock was strong. Despite the market responding positively, we think that there are several concerning factors that investors should be aware of.

See our latest analysis for Nexchip Semiconductor

A Closer Look At Nexchip Semiconductor'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. 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.

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 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".

Over the twelve months to December 2023, Nexchip Semiconductor recorded an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of CN¥7.6b, in contrast to the aforementioned profit of CN¥211.6m. We also note that Nexchip Semiconductor's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥7.6b. 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.

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?

Given the accrual ratio, it's not overly surprising that Nexchip Semiconductor's profit was boosted by unusual items worth CN¥93m in the last twelve months. 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. We can see that Nexchip Semiconductor'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 Nexchip Semiconductor's Profit Performance

Nexchip Semiconductor had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Nexchip Semiconductor's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Nexchip Semiconductor as a business, it's important to be aware of any risks it's facing. Our analysis shows 2 warning signs for Nexchip Semiconductor (1 is a bit concerning!) and we strongly recommend you look at them before investing.

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 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 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.