Founder Technology GroupLtd (SHSE:600601) Strong Profits May Be Masking Some Underlying Issues

The recent earnings posted by Founder Technology Group Co.,Ltd. (SHSE:600601) were solid, but the stock didn't move as much as we expected. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

See our latest analysis for Founder Technology GroupLtd

Examining Cashflow Against Founder Technology GroupLtd'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Founder Technology GroupLtd had an accrual ratio of 0.22. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥226.3m, a look at free cash flow indicates it actually burnt through CN¥497m in the last year. We saw that FCF was CN¥113m a year ago though, so Founder Technology GroupLtd has at least been able to generate positive FCF in the past. 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.

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Founder Technology GroupLtd's profit was boosted by unusual items worth CN¥29m 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. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Founder Technology GroupLtd 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 Founder Technology GroupLtd's Profit Performance

Summing up, Founder Technology GroupLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Founder Technology GroupLtd's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. While conducting our analysis, we found that Founder Technology GroupLtd has 1 warning sign and it would be unwise to ignore this.

Our examination of Founder Technology GroupLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with significant insider holdings 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.