Camelot Electronics TechnologyLtd's (SZSE:301282) Soft Earnings Are Actually Better Than They Appear

Camelot Electronics Technology Co.,Ltd.'s (SZSE:301282) stock was strong despite it releasing a soft earnings report last week. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.

See our latest analysis for Camelot Electronics TechnologyLtd

Zooming In On Camelot Electronics TechnologyLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

Camelot Electronics TechnologyLtd has an accrual ratio of 0.20 for the year to December 2023. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥42.4m, a look at free cash flow indicates it actually burnt through CN¥190m in the last year. We also note that Camelot Electronics 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¥190m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Camelot Electronics TechnologyLtd saw its profit reduced by unusual items worth CN¥18m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Camelot Electronics TechnologyLtd to produce a higher profit next year, all else being equal.

Our Take On Camelot Electronics TechnologyLtd's Profit Performance

In conclusion, Camelot Electronics TechnologyLtd's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Considering all the aforementioned, we'd venture that Camelot Electronics TechnologyLtd's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Camelot Electronics TechnologyLtd has 4 warning signs (2 don't sit too well with us!) that deserve your attention before going any further with your analysis.

Our examination of Camelot Electronics TechnologyLtd has focussed on certain factors that can make its earnings look better than they are. 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. 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 that insiders are buying 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.