We Think That There Are More Issues For Shenzhen SEICHI Technologies (SHSE:688627) Than Just Sluggish Earnings

Shenzhen SEICHI Technologies Co., Ltd.'s (SHSE:688627) stock wasn't much affected by its recent lackluster earnings numbers. We did some analysis and found some concerning details beneath the statutory profit number.

See our latest analysis for Shenzhen SEICHI Technologies

Examining Cashflow Against Shenzhen SEICHI Technologies' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Shenzhen SEICHI Technologies has an accrual ratio of 0.35 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of CN¥112.2m, a look at free cash flow indicates it actually burnt through CN¥105m in the last year. We saw that FCF was CN¥16m a year ago though, so Shenzhen SEICHI Technologies has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥31m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. And, after all, that's exactly what the accounting terminology implies. Shenzhen SEICHI Technologies had a rather significant contribution from unusual items relative to its profit to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Shenzhen SEICHI Technologies' Profit Performance

Summing up, Shenzhen SEICHI Technologies 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 Shenzhen SEICHI Technologies' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Shenzhen SEICHI Technologies as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for Shenzhen SEICHI Technologies (1 makes us a bit uncomfortable!) and we strongly recommend you look at them before investing.

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 with high insider ownership.

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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.