Solid Earnings Reflect Shanghai Qingpu Fire-Fighting Equipment's (HKG:8115) Strength As A Business

Shanghai Qingpu Fire-Fighting Equipment Co., Ltd. (HKG:8115) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.

Check out our latest analysis for Shanghai Qingpu Fire-Fighting Equipment

A Closer Look At Shanghai Qingpu Fire-Fighting Equipment'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. 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. 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 December 2023, Shanghai Qingpu Fire-Fighting Equipment had an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥13m in the last year, which was a lot more than its statutory profit of CN¥8.52m. Shanghai Qingpu Fire-Fighting Equipment shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanghai Qingpu Fire-Fighting Equipment.

How Do Unusual Items Influence Profit?

Surprisingly, given Shanghai Qingpu Fire-Fighting Equipment's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥2.6m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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 that's as you'd expect, given these boosts are described as 'unusual'. Shanghai Qingpu Fire-Fighting Equipment had a rather significant contribution from unusual items relative to its profit to December 2023. 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 Shanghai Qingpu Fire-Fighting Equipment's Profit Performance

Shanghai Qingpu Fire-Fighting Equipment's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Shanghai Qingpu Fire-Fighting Equipment's profits are an apt reflection of its underlying potential for profit. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 2 warning signs with Shanghai Qingpu Fire-Fighting Equipment, and understanding these should be part of your investment process.

Our examination of Shanghai Qingpu Fire-Fighting Equipment has focussed on certain factors that can make its earnings look better than they are. 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.