Wenzhou Hongfeng Electrical Alloy Co., Ltd.'s (SZSE:300283) lackluster earnings announcement last week disappointed investors. We think there is more to the story than simply soft profit numbers. Our analysis shows that there are some other factors of concern.

The Power Of Non-Operating Revenue

Companies will classify their revenue streams as either operating revenue or other revenue. Where possible, we prefer rely on operating revenue to get a better understanding of how the business is functioning. However, we note that when non-operating revenue increases suddenly, it will sometimes generate an unsustainable boost to profit. Notably, Wenzhou Hongfeng Electrical Alloy had a significant increase in non-operating revenue over the last year. Indeed, its non-operating revenue rose from CN¥162.4m last year to CN¥595.5m this year. If that non-operating revenue fails to manifest in the current year, then there's a real risk the bottom line profit result will be impacted negatively. In order to better understand a company's profit result, it can sometimes help to consider whether the result would be very different without a sudden increase in non-operating revenue.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wenzhou Hongfeng Electrical Alloy.

How Do Unusual Items Influence Profit?

Alongside that spike in non-operating revenue, it's also important to note that Wenzhou Hongfeng Electrical Alloy'sprofit was boosted by unusual items worth CN¥19m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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, after all, that's exactly what the accounting terminology implies. Wenzhou Hongfeng Electrical Alloy 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 Wenzhou Hongfeng Electrical Alloy's Profit Performance

In the last year Wenzhou Hongfeng Electrical Alloy's non-operating revenue really gave it a boost, but not in a way that is necessarily going to be sustained. And on top of that, it also saw an unusual item boost its profit, suggesting that next year might see a lower profit number, if these events are not repeated and everything else is equal. On reflection, the above-mentioned factors give us the strong impression that Wenzhou Hongfeng Electrical Alloy'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 4 warning signs for Wenzhou Hongfeng Electrical Alloy (of which 1 makes us a bit uncomfortable!) you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.

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.