ArcherMind Technology (Nanjing)'s (SZSE:300598) Earnings Are Weaker Than They Seem

Despite posting some strong earnings, the market for ArcherMind Technology (Nanjing) Co., Ltd.'s (SZSE:300598) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

Check out our latest analysis for ArcherMind Technology (Nanjing)

Examining Cashflow Against ArcherMind Technology (Nanjing)'s Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, ArcherMind Technology (Nanjing) recorded an accrual ratio of 0.28. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥103m, in contrast to the aforementioned profit of CN¥207.6m. We also note that ArcherMind Technology (Nanjing)'s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥103m. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that ArcherMind Technology (Nanjing)'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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ArcherMind Technology (Nanjing).

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥5.0m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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 ArcherMind Technology (Nanjing) doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On ArcherMind Technology (Nanjing)'s Profit Performance

ArcherMind Technology (Nanjing) had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue ArcherMind Technology (Nanjing)'s profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example - ArcherMind Technology (Nanjing) has 2 warning signs we think you should be aware of.

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. 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.