Ways ElectronLtd (SHSE:605218) Is Posting Healthy Earnings, But It Is Not All Good News

Despite posting strong earnings, Ways Electron Co.,Ltd.'s (SHSE:605218) stock didn't move much over the last week. We think that investors might be worried about the foundations the earnings are built on.

View our latest analysis for Ways ElectronLtd

Examining Cashflow Against Ways ElectronLtd'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. 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. 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, Ways ElectronLtd had an accrual ratio of 0.42. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥142m despite its profit of CN¥118.0m, mentioned above. It's worth noting that Ways ElectronLtd generated positive FCF of CN¥93m a year ago, so at least they've done it 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 Ways ElectronLtd.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥35m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Ways ElectronLtd had a rather significant contribution from unusual items relative to its profit to December 2023. 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 Ways ElectronLtd's Profit Performance

Ways ElectronLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. For all the reasons mentioned above, we think that, at a glance, Ways ElectronLtd's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you'd like to know more about Ways ElectronLtd as a business, it's important to be aware of any risks it's facing. For example, we've found that Ways ElectronLtd has 4 warning signs (2 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

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 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. 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.