Weak Statutory Earnings May Not Tell The Whole Story For WCON Electronics (Guangdong) (SZSE:301328)

A lackluster earnings announcement from WCON Electronics (Guangdong) Co., Ltd. (SZSE:301328) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for WCON Electronics (Guangdong)

Examining Cashflow Against WCON Electronics (Guangdong)'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

WCON Electronics (Guangdong) has an accrual ratio of 0.25 for the year to September 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥94m, in contrast to the aforementioned profit of CN¥97.1m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥94m, 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.

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¥11m, 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. If WCON Electronics (Guangdong) doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On WCON Electronics (Guangdong)'s Profit Performance

WCON Electronics (Guangdong) had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at WCON Electronics (Guangdong)'s statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 2 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in WCON Electronics (Guangdong).

Our examination of WCON Electronics (Guangdong) 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 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 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.