Union Semiconductor (Hefei)'s (SHSE:688403) Shareholders May Want To Dig Deeper Than Statutory Profit

The recent earnings posted by Union Semiconductor (Hefei) Co., Ltd. (SHSE:688403) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

See our latest analysis for Union Semiconductor (Hefei)

Zooming In On Union Semiconductor (Hefei)'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2024, Union Semiconductor (Hefei) had an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥173.6m, a look at free cash flow indicates it actually burnt through CN¥585m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥585m, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Union Semiconductor (Hefei).

Our Take On Union Semiconductor (Hefei)'s Profit Performance

Union Semiconductor (Hefei)'s accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Union Semiconductor (Hefei)'s true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Union Semiconductor (Hefei) at this point in time. Be aware that Union Semiconductor (Hefei) is showing 2 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

This note has only looked at a single factor that sheds light on the nature of Union Semiconductor (Hefei)'s profit. 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.