China Crystal New Material HoldingsLtd's (KOSDAQ:900250) Soft Earnings Are Actually Better Than They Appear

Shareholders appeared unconcerned with China Crystal New Material Holdings Co.,Ltd.'s (KOSDAQ:900250) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for China Crystal New Material HoldingsLtd

Zooming In On China Crystal New Material HoldingsLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2024, China Crystal New Material HoldingsLtd recorded an accrual ratio of -0.18. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of ₩50b during the period, dwarfing its reported profit of ₩7.86b. China Crystal New Material HoldingsLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. However, that's not all there is to consider. 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 China Crystal New Material HoldingsLtd.

The Impact Of Unusual Items On Profit

China Crystal New Material HoldingsLtd's profit was reduced by unusual items worth ₩8.4b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect China Crystal New Material HoldingsLtd to produce a higher profit next year, all else being equal.

Our Take On China Crystal New Material HoldingsLtd's Profit Performance

In conclusion, both China Crystal New Material HoldingsLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon China Crystal New Material HoldingsLtd's statutory profit probably understates its earnings potential! If you want to do dive deeper into China Crystal New Material HoldingsLtd, you'd also look into what risks it is currently facing. Be aware that China Crystal New Material HoldingsLtd is showing 4 warning signs in our investment analysis and 1 of those is potentially serious...

Our examination of China Crystal New Material HoldingsLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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 with significant insider holdings to be useful.

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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.