Southchip Semiconductor Technology(Shanghai)'s (SHSE:688484) Profits May Not Reveal Underlying Issues

Southchip Semiconductor Technology(Shanghai) Co., Ltd.'s (SHSE:688484 ) stock didn't jump after it announced some healthy earnings. We did some digging and believe investors may be worried about some underlying factors in the report.

Check out our latest analysis for Southchip Semiconductor Technology(Shanghai)

A Closer Look At Southchip Semiconductor Technology(Shanghai)'s Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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, Southchip Semiconductor Technology(Shanghai) recorded an accrual ratio of 0.59. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥97m despite its profit of CN¥261.4m, mentioned above. We saw that FCF was CN¥302m a year ago though, so Southchip Semiconductor Technology(Shanghai) has at least been able to generate positive FCF in the past. One positive for Southchip Semiconductor Technology(Shanghai) shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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 Southchip Semiconductor Technology(Shanghai)'s Profit Performance

As we discussed above, we think Southchip Semiconductor Technology(Shanghai)'s earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Southchip Semiconductor Technology(Shanghai)'s statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 2 warning signs for Southchip Semiconductor Technology(Shanghai) (1 is potentially serious!) and we strongly recommend you look at these before investing.

Today we've zoomed in on a single data point to better understand the nature of Southchip Semiconductor Technology(Shanghai)'s profit. 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.