We Think Jinan Acetate Chemical's (TWSE:4763) Profit Is Only A Baseline For What They Can Achieve

The subdued stock price reaction suggests that Jinan Acetate Chemical Co., Ltd.'s (TWSE:4763) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

View our latest analysis for Jinan Acetate Chemical

Examining Cashflow Against Jinan Acetate Chemical'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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 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.

Jinan Acetate Chemical has an accrual ratio of -0.33 for the year to December 2023. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of NT$5.8b, well over the NT$5.18b it reported in profit. Jinan Acetate Chemical shareholders are no doubt pleased that free cash flow improved over the last twelve months. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jinan Acetate Chemical.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Jinan Acetate Chemical expanded the number of shares on issue by 9.9% over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Jinan Acetate Chemical's EPS by clicking here.

How Is Dilution Impacting Jinan Acetate Chemical's Earnings Per Share (EPS)?

Jinan Acetate Chemical has improved its profit over the last three years, with an annualized gain of 926% in that time. But EPS was only up 715% per year, in the exact same period. And the 314% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 255% over the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Jinan Acetate Chemical shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Jinan Acetate Chemical's Profit Performance

At the end of the day, Jinan Acetate Chemical is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Considering all the aforementioned, we'd venture that Jinan Acetate Chemical's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about Jinan Acetate Chemical as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 2 warning signs for Jinan Acetate Chemical and we think they deserve your attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.