Fujian Highton Development's (SHSE:603162) Shareholders Have More To Worry About Than Only Soft Earnings

The subdued market reaction suggests that Fujian Highton Development Co., Ltd.'s (SHSE:603162) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Fujian Highton Development

Zooming In On Fujian Highton Development's 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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, Fujian Highton Development recorded an accrual ratio of 0.51. 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¥785m, in contrast to the aforementioned profit of CN¥185.0m. We saw that FCF was CN¥791m a year ago though, so Fujian Highton Development has at least been able to generate positive FCF in the past. One positive for Fujian Highton Development 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 Fujian Highton Development.

Our Take On Fujian Highton Development's Profit Performance

As we discussed above, we think Fujian Highton Development's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Fujian Highton Development's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Fujian Highton Development, you'd also look into what risks it is currently facing. Be aware that Fujian Highton Development is showing 3 warning signs in our investment analysis and 1 of those is potentially serious...

This note has only looked at a single factor that sheds light on the nature of Fujian Highton Development's profit. 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 that insiders are buying.

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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.