Shenzhen Longsys Electronics' (SZSE:301308) Earnings Aren't As Good As They Appear

Strong earnings weren't enough to please Shenzhen Longsys Electronics Co., Ltd.'s (SZSE:301308) shareholders over the last week. We did some digging and found some underlying numbers that are worrying.

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Examining Cashflow Against Shenzhen Longsys Electronics' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2024, Shenzhen Longsys Electronics had an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥498.7m, a look at free cash flow indicates it actually burnt through CN¥2.1b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥2.1b, this year, indicates high risk. 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.

Check out our latest analysis for Shenzhen Longsys Electronics

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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥350m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. Which is hardly surprising, given the name. We can see that Shenzhen Longsys Electronics' positive unusual items were quite significant relative to its profit in the year to December 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 Longsys Electronics' Profit Performance

Shenzhen Longsys Electronics had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shenzhen Longsys Electronics' profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Shenzhen Longsys Electronics at this point in time. While conducting our analysis, we found that Shenzhen Longsys Electronics has 2 warning signs and it would be unwise to ignore these.

Our examination of Shenzhen Longsys Electronics has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.