Shenzhen Edadoc TechnologyLtd's (SZSE:301366) Anemic Earnings Might Be Worse Than You Think

The market wasn't impressed with the soft earnings from Shenzhen Edadoc Technology Co.,Ltd. (SZSE:301366) recently. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

See our latest analysis for Shenzhen Edadoc TechnologyLtd

A Closer Look At Shenzhen Edadoc TechnologyLtd'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). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Shenzhen Edadoc TechnologyLtd has an accrual ratio of 0.24 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥165m despite its profit of CN¥107.9m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥165m, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Shenzhen Edadoc TechnologyLtd's profit was boosted by unusual items worth CN¥22m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. Shenzhen Edadoc TechnologyLtd had a rather significant contribution from unusual items relative to its profit to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Shenzhen Edadoc TechnologyLtd's Profit Performance

Shenzhen Edadoc TechnologyLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shenzhen Edadoc TechnologyLtd'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. Case in point: We've spotted 4 warning signs for Shenzhen Edadoc TechnologyLtd you should be mindful of and 3 of these are a bit unpleasant.

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 is always more to discover if you are capable of focussing your mind on minutiae. 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 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.