Konfoong Materials International (SZSE:300666) Shareholders Should Be Cautious Despite Solid Earnings

Shareholders didn't seem to be thrilled with Konfoong Materials International Co., Ltd's (SZSE:300666) recent earnings report, despite healthy profit numbers. We think that they might be concerned about some underlying details that our analysis found.

View our latest analysis for Konfoong Materials International

Zooming In On Konfoong Materials International'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Over the twelve months to September 2024, Konfoong Materials International recorded an accrual ratio of 0.36. 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. Even though it reported a profit of CN¥349.2m, a look at free cash flow indicates it actually burnt through CN¥1.4b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥1.4b, this year, indicates high risk. However, that's not all there is to consider. 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?

Given the accrual ratio, it's not overly surprising that Konfoong Materials International's profit was boosted by unusual items worth CN¥56m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Konfoong Materials International doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Konfoong Materials International's Profit Performance

Summing up, Konfoong Materials International received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Konfoong Materials International's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Konfoong Materials International as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for Konfoong Materials International (of which 1 is potentially serious!) you should know about.

Our examination of Konfoong Materials International 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 with significant insider holdings 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.