Why NOVA Technology's (SZSE:300921) Earnings Are Weaker Than They Seem

Investors were disappointed with NOVA Technology Corporation Limited's (SZSE:300921) recent earnings release. We did some digging and found some underlying numbers that are worrying.

Check out our latest analysis for NOVA Technology

Examining Cashflow Against NOVA Technology'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

For the year to September 2024, NOVA Technology had an accrual ratio of 0.21. 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¥9.8m despite its profit of CN¥27.7m, mentioned above. It's worth noting that NOVA Technology generated positive FCF of CN¥36m a year ago, so at least they've done it in the past. 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. One positive for NOVA Technology shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of NOVA Technology.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥15m, 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. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. We can see that NOVA Technology's positive unusual items were quite significant relative to its profit in the year to September 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 NOVA Technology's Profit Performance

NOVA Technology 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 NOVA Technology's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into NOVA Technology, you'd also look into what risks it is currently facing. For example, we've found that NOVA Technology has 4 warning signs (3 make us uncomfortable!) that deserve your attention before going any further with your analysis.

Our examination of NOVA Technology 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.