Long Young Electronic (Kunshan)'s (SZSE:301389) Problems Go Beyond Poor Profit

After announcing weak earnings, Long Young Electronic (Kunshan) Co., Ltd.'s (SZSE:301389) stock was strong. Despite the market responding positively, we think that there are several concerning factors that investors should be aware of.

See our latest analysis for Long Young Electronic (Kunshan)

Zooming In On Long Young Electronic (Kunshan)'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. 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 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.

Over the twelve months to December 2023, Long Young Electronic (Kunshan) recorded an accrual ratio of 0.49. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥19m, in contrast to the aforementioned profit of CN¥96.8m. We saw that FCF was CN¥156m a year ago though, so Long Young Electronic (Kunshan) has at least been able to generate positive FCF in the past. Having said that, there is more to the story. 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

Given the accrual ratio, it's not overly surprising that Long Young Electronic (Kunshan)'s profit was boosted by unusual items worth CN¥3.8m 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. 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. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Long Young Electronic (Kunshan)'s Profit Performance

Summing up, Long Young Electronic (Kunshan) received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Long Young Electronic (Kunshan)'s 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 Long Young Electronic (Kunshan) at this point in time. Be aware that Long Young Electronic (Kunshan) is showing 3 warning signs in our investment analysis and 1 of those is potentially serious...

Our examination of Long Young Electronic (Kunshan) 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. 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.