Gstarsoft's (SHSE:688657) Soft Earnings Are Actually Better Than They Appear

Shareholders appeared unconcerned with Gstarsoft Co., Ltd.'s (SHSE:688657) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

Check out our latest analysis for Gstarsoft

Examining Cashflow Against Gstarsoft'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 December 2023, Gstarsoft had an accrual ratio of -0.28. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥66m during the period, dwarfing its reported profit of CN¥54.1m. Gstarsoft shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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

Our Take On Gstarsoft's Profit Performance

As we discussed above, Gstarsoft's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Gstarsoft's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And we are pleased to note that EPS is at least heading in the right direction over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. You can see our latest analysis on Gstarsoft's balance sheet health here.

This note has only looked at a single factor that sheds light on the nature of Gstarsoft'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.