Investors Shouldn't Be Too Comfortable With Guizhou Zhenhua Fengguang Semiconductor's (SHSE:688439) Earnings

Despite posting some strong earnings, the market for Guizhou Zhenhua Fengguang Semiconductor Co., Ltd.'s (SHSE:688439) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

Check out our latest analysis for Guizhou Zhenhua Fengguang Semiconductor

Examining Cashflow Against Guizhou Zhenhua Fengguang Semiconductor'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. The ratio shows us how much a company's profit exceeds its FCF.

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 March 2024, Guizhou Zhenhua Fengguang Semiconductor recorded an accrual ratio of 0.54. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥481m despite its profit of CN¥621.6m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥481m, this year, indicates high risk.

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.

Our Take On Guizhou Zhenhua Fengguang Semiconductor's Profit Performance

As we discussed above, we think Guizhou Zhenhua Fengguang Semiconductor's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Guizhou Zhenhua Fengguang Semiconductor's underlying earnings power is lower 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. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Guizhou Zhenhua Fengguang Semiconductor as a business, it's important to be aware of any risks it's facing. For example - Guizhou Zhenhua Fengguang Semiconductor has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Guizhou Zhenhua Fengguang Semiconductor's profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.