We Think That There Are More Issues For Hebei Sinopack Electronic TechnologyLtd (SZSE:003031) Than Just Sluggish Earnings

After announcing weak earnings, Hebei Sinopack Electronic Technology Co.,Ltd.'s (SZSE:003031) stock was strong. While shares were up, we believe there are some factors in the earnings report that might cause investors some concerns.

See our latest analysis for Hebei Sinopack Electronic TechnologyLtd

Zooming In On Hebei Sinopack Electronic TechnologyLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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.

Hebei Sinopack Electronic TechnologyLtd has an accrual ratio of 0.26 for the year to June 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of CN¥34m in the last year, which was a lot less than its statutory profit of CN¥475.7m. Hebei Sinopack Electronic TechnologyLtd 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, Hebei Sinopack Electronic TechnologyLtd increased the number of shares on issue by 54% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Hebei Sinopack Electronic TechnologyLtd's EPS by clicking here.

How Is Dilution Impacting Hebei Sinopack Electronic TechnologyLtd's Earnings Per Share (EPS)?

As you can see above, Hebei Sinopack Electronic TechnologyLtd has been growing its net income over the last few years, with an annualized gain of 334% over three years. But EPS was only up 153% per year, in the exact same period. Net income was down 22% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 57%. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Hebei Sinopack Electronic TechnologyLtd's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Hebei Sinopack Electronic TechnologyLtd's Profit Performance

In conclusion, Hebei Sinopack Electronic TechnologyLtd has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Hebei Sinopack Electronic TechnologyLtd's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Hebei Sinopack Electronic TechnologyLtd at this point in time. For example - Hebei Sinopack Electronic TechnologyLtd has 2 warning signs we think you should be aware of.

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. 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.