We Think That There Are More Issues For Ningbo Shimao EnergyLtd (SHSE:605028) Than Just Sluggish Earnings

A lackluster earnings announcement from Ningbo Shimao Energy Co.,Ltd (SHSE:605028) last week didn't sink the stock price. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out our latest analysis for Ningbo Shimao EnergyLtd

Examining Cashflow Against Ningbo Shimao EnergyLtd'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. 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Ningbo Shimao EnergyLtd recorded an accrual ratio of 0.32. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥12m despite its profit of CN¥188.2m, mentioned above. We saw that FCF was CN¥56m a year ago though, so Ningbo Shimao EnergyLtd has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ningbo Shimao EnergyLtd.

Our Take On Ningbo Shimao EnergyLtd's Profit Performance

As we discussed above, we think Ningbo Shimao EnergyLtd's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Ningbo Shimao EnergyLtd's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 17% per annum growth in EPS for the last three. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Ningbo Shimao EnergyLtd at this point in time. Be aware that Ningbo Shimao EnergyLtd is showing 2 warning signs in our investment analysis and 1 of those is a bit unpleasant...

Today we've zoomed in on a single data point to better understand the nature of Ningbo Shimao EnergyLtd'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.