Wuxi DK Electronic MaterialsLtd's (SZSE:300842) Promising Earnings May Rest On Soft Foundations

Wuxi DK Electronic Materials Co.,Ltd. (SZSE:300842) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out our latest analysis for Wuxi DK Electronic MaterialsLtd

A Closer Look At Wuxi DK Electronic MaterialsLtd'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2024, Wuxi DK Electronic MaterialsLtd had an accrual ratio of 0.38. 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. Even though it reported a profit of CN¥475.1m, a look at free cash flow indicates it actually burnt through CN¥284m 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¥284m, this year, indicates high risk.

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 DK Electronic MaterialsLtd's Profit Performance

As we discussed above, we think Wuxi DK Electronic MaterialsLtd'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 Wuxi DK Electronic MaterialsLtd'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. So while earnings quality is important, it's equally important to consider the risks facing Wuxi DK Electronic MaterialsLtd at this point in time. Every company has risks, and we've spotted 2 warning signs for Wuxi DK Electronic MaterialsLtd (of which 1 is concerning!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Wuxi DK Electronic MaterialsLtd's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.