Smartgiant Technology's (SHSE:688115) Shareholders Have More To Worry About Than Only Soft Earnings

The market rallied behind Smartgiant Technology Co., Ltd.'s (SHSE:688115) stock, leading do a rise in the share price after its recent 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.

See our latest analysis for Smartgiant Technology

Zooming In On Smartgiant Technology'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. 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 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.

Smartgiant Technology has an accrual ratio of 0.23 for the year to March 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥22.0m, a look at free cash flow indicates it actually burnt through CN¥60m in the last year. We also note that Smartgiant Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥60m.

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

Our Take On Smartgiant Technology's Profit Performance

Smartgiant Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Smartgiant Technology's true underlying earnings power is actually less 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. So while earnings quality is important, it's equally important to consider the risks facing Smartgiant Technology at this point in time. When we did our research, we found 4 warning signs for Smartgiant Technology (3 are potentially serious!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Smartgiant Technology'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.