Shenzhen S.C New Energy Technology's (SZSE:300724) Profits Appear To Have Quality Issues

The market shrugged off Shenzhen S.C New Energy Technology Corporation's (SZSE:300724) solid earnings report. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

Check out our latest analysis for Shenzhen S.C New Energy Technology

Examining Cashflow Against Shenzhen S.C New Energy Technology'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

For the year to September 2024, Shenzhen S.C New Energy Technology had an accrual ratio of 0.37. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of CN¥1.8b during the period, falling well short of its reported profit of CN¥2.43b. Shenzhen S.C New Energy Technology'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. The good news for shareholders is that Shenzhen S.C New Energy Technology's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Shenzhen S.C New Energy Technology's Profit Performance

As we discussed above, we think Shenzhen S.C New Energy Technology's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Shenzhen S.C New Energy Technology's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Shenzhen S.C New Energy Technology is showing 3 warning signs in our investment analysis and 2 of those don't sit too well with us...

Today we've zoomed in on a single data point to better understand the nature of Shenzhen S.C New Energy Technology's profit. 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.