Wuxi Autowell TechnologyLtd's (SHSE:688516) Solid Earnings May Rest On Weak Foundations

The stock price didn't jump after Wuxi Autowell Technology Co.,Ltd. (SHSE:688516) posted decent earnings last week. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

See our latest analysis for Wuxi Autowell TechnologyLtd

Examining Cashflow Against Wuxi Autowell TechnologyLtd'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. 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. 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. 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. 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, Wuxi Autowell TechnologyLtd recorded an accrual ratio of 0.50. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of CN¥224m, which is significantly less than its profit of CN¥1.26b. Wuxi Autowell TechnologyLtd's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

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 Wuxi Autowell TechnologyLtd's Profit Performance

As we have made quite clear, we're a bit worried that Wuxi Autowell TechnologyLtd didn't back up the last year's profit with free cashflow. For this reason, we think that Wuxi Autowell TechnologyLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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 Wuxi Autowell TechnologyLtd at this point in time. For example, Wuxi Autowell TechnologyLtd has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Wuxi Autowell TechnologyLtd'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. 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.