We Think That There Are Some Issues For Qingdao Gaoce Technology (SHSE:688556) Beyond Its Promising Earnings

The market shrugged off Qingdao Gaoce Technology Co., Ltd's (SHSE:688556) solid earnings report. We think that investors might be worried about some concerning underlying factors.

View our latest analysis for Qingdao Gaoce Technology

A Closer Look At Qingdao Gaoce Technology'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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Qingdao Gaoce Technology has an accrual ratio of 0.26 for the year to March 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Indeed, in the last twelve months it reported free cash flow of CN¥701m, which is significantly less than its profit of CN¥1.34b. Given that Qingdao Gaoce Technology had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥701m would seem to be a step in the right direction. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Qingdao Gaoce Technology expanded the number of shares on issue by 6.3% over the last year. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Qingdao Gaoce Technology's EPS by clicking here.

How Is Dilution Impacting Qingdao Gaoce Technology's Earnings Per Share (EPS)?

As you can see above, Qingdao Gaoce Technology has been growing its net income over the last few years, with an annualized gain of 2,195% over three years. But EPS was only up 1,873% per year, in the exact same period. And at a glance the 30% gain in profit over the last year impresses. But in comparison, EPS only increased by 24% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Qingdao Gaoce Technology shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Qingdao Gaoce Technology's Profit Performance

In conclusion, Qingdao Gaoce Technology has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at Qingdao Gaoce Technology's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Qingdao Gaoce Technology as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for Qingdao Gaoce Technology (1 is significant) you should be familiar with.

Our examination of Qingdao Gaoce Technology has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 that insiders are buying to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.