SUPCON Technology (SHSE:688777) Shareholders Should Be Cautious Despite Solid Earnings

Solid profit numbers didn't seem to be enough to please SUPCON Technology Co., Ltd.'s (SHSE:688777) shareholders. We think that they might be concerned about some underlying details that our analysis found.

Check out our latest analysis for SUPCON Technology

Examining Cashflow Against SUPCON Technology'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). 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. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, SUPCON Technology recorded an accrual ratio of 0.41. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of CN¥66m, which is significantly less than its profit of CN¥1.10b. SUPCON Technology shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, SUPCON Technology increased the number of shares on issue by 8.8% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of SUPCON Technology's EPS by clicking here.

A Look At The Impact Of SUPCON Technology's Dilution On Its Earnings Per Share (EPS)

As you can see above, SUPCON Technology has been growing its net income over the last few years, with an annualized gain of 160% over three years. In comparison, earnings per share only gained 120% over the same period. And the 38% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 30% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So SUPCON Technology shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On SUPCON Technology's Profit Performance

As it turns out, SUPCON Technology couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue SUPCON Technology's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with SUPCON Technology (including 1 which is concerning).

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. 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.