PowerTECH's (SZSE:301369) Weak Earnings May Only Reveal A Part Of The Whole Picture

The market shrugged off PowerTECH Co., Ltd.'s (SZSE:301369) weak earnings report last week. We did some analysis and found some positive factors that investors might be paying attention to rather than profit.

Check out our latest analysis for PowerTECH

Examining Cashflow Against PowerTECH'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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 March 2024, PowerTECH had an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥43m, in contrast to the aforementioned profit of CN¥20.1m. It's worth noting that PowerTECH generated positive FCF of CN¥96m a year ago, so at least they've done it in the past. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of PowerTECH.

The Impact Of Unusual Items On Profit

PowerTECH's profit suffered from unusual items, which reduced profit by CN¥1.8m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If PowerTECH doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On PowerTECH's Profit Performance

PowerTECH saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Given the contrasting considerations, we don't have a strong view as to whether PowerTECH's profits are an apt reflection of its underlying potential for profit. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that PowerTECH is showing 5 warning signs in our investment analysis and 4 of those are a bit concerning...

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.

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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.