There Might Be More To Shanghai Fudan Microelectronics Group's (HKG:1385) Story Than Just Weak Earnings

Shanghai Fudan Microelectronics Group Company Limited's (HKG:1385) lackluster earnings announcement last week disappointed investors. We think that they may have more to worry about than just soft profit numbers.

Check out our latest analysis for Shanghai Fudan Microelectronics Group

A Closer Look At Shanghai Fudan Microelectronics Group'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2023, Shanghai Fudan Microelectronics Group had an accrual ratio of 0.44. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥719.5m, a look at free cash flow indicates it actually burnt through CN¥1.6b in the last year. We also note that Shanghai Fudan Microelectronics Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.6b. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Shanghai Fudan Microelectronics Group's profit was boosted by unusual items worth CN¥140m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. 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 Shanghai Fudan Microelectronics Group's Profit Performance

Summing up, Shanghai Fudan Microelectronics Group received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Shanghai Fudan Microelectronics Group's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Shanghai Fudan Microelectronics Group, you'd also look into what risks it is currently facing. For example, we've found that Shanghai Fudan Microelectronics Group has 3 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

Our examination of Shanghai Fudan Microelectronics Group 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 are plenty of other ways to inform your opinion of a company. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.