Keystone TechnologyLtd's (SHSE:605588) Anemic Earnings Might Be Worse Than You Think

Keystone Technology Co.,Ltd.'s (SHSE:605588) stock showed strength, with investors undeterred by its weak earnings report. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

View our latest analysis for Keystone TechnologyLtd

Zooming In On Keystone TechnologyLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2024, Keystone TechnologyLtd recorded an accrual ratio of 0.69. Statistically speaking, that's a real negative for future earnings. 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¥569m, in contrast to the aforementioned profit of CN¥43.3m. We also note that Keystone TechnologyLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥569m.

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

Our Take On Keystone TechnologyLtd's Profit Performance

As we have made quite clear, we're a bit worried that Keystone TechnologyLtd didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Keystone TechnologyLtd's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. If you want to do dive deeper into Keystone TechnologyLtd, you'd also look into what risks it is currently facing. For example, we've found that Keystone TechnologyLtd has 4 warning signs (2 make us uncomfortable!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of Keystone TechnologyLtd's profit. 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. 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.