Yonyou Auto Information Technology (Shanghai)Ltd's (SHSE:688479) Earnings Are Built On Soft Foundations

Shareholders were pleased with the recent earnings report from Yonyou Auto Information Technology (Shanghai) Co.,Ltd (SHSE:688479). However, we think that investors should be cautious when interpreting the profit numbers.

Check out our latest analysis for Yonyou Auto Information Technology (Shanghai)Ltd

Zooming In On Yonyou Auto Information Technology (Shanghai)Ltd'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. 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.

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".

Yonyou Auto Information Technology (Shanghai)Ltd has an accrual ratio of 0.75 for the year to March 2024. 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. Over the last year it actually had negative free cash flow of CN¥97m, in contrast to the aforementioned profit of CN¥110.5m. We saw that FCF was CN¥28m a year ago though, so Yonyou Auto Information Technology (Shanghai)Ltd has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Yonyou Auto Information Technology (Shanghai)Ltd.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Yonyou Auto Information Technology (Shanghai)Ltd's profit was boosted by unusual items worth CN¥41m 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. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. Yonyou Auto Information Technology (Shanghai)Ltd had a rather significant contribution from unusual items relative to its profit to March 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Yonyou Auto Information Technology (Shanghai)Ltd's Profit Performance

Yonyou Auto Information Technology (Shanghai)Ltd had a weak accrual ratio, but its profit did receive a boost from unusual items. On reflection, the above-mentioned factors give us the strong impression that Yonyou Auto Information Technology (Shanghai)Ltd'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 2 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Yonyou Auto Information Technology (Shanghai)Ltd.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.