Weak Statutory Earnings May Not Tell The Whole Story For Changzhou Fusion New Material (SHSE:688503)

Following the release of a lackluster earnings report from Changzhou Fusion New Material Co., Ltd. (SHSE:688503) the stock price made a strong positive move. We looked at the details, and we think that investors may be responding to some encouraging factors.

Check out our latest analysis for Changzhou Fusion New Material

Examining Cashflow Against Changzhou Fusion New Material's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. 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.

Changzhou Fusion New Material has an accrual ratio of 0.37 for the year to September 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥1.7b, in contrast to the aforementioned profit of CN¥422.4m. We also note that Changzhou Fusion New Material's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.7b. 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?

Changzhou Fusion New Material's profit suffered from unusual items, which reduced profit by CN¥64m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Changzhou Fusion New Material to produce a higher profit next year, all else being equal.

Our Take On Changzhou Fusion New Material's Profit Performance

Changzhou Fusion New Material saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Based on these factors, we think it's very unlikely that Changzhou Fusion New Material's statutory profits make it seem much weaker than it is. If you'd like to know more about Changzhou Fusion New Material as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 4 warning signs for Changzhou Fusion New Material you should be mindful of and 1 of these bad boys doesn't sit too well with us.

Our examination of Changzhou Fusion New Material has focussed on certain factors that can make its earnings look better than they are. 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 with high insider ownership.

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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.