Solid profit numbers didn't seem to be enough to please Sinosteel Engineering & Technology Co., Ltd.'s (SZSE:000928) shareholders. Our analysis suggests they may be concerned about some underlying details.

Zooming In On Sinosteel Engineering & Technology'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Over the twelve months to March 2024, Sinosteel Engineering & Technology recorded an accrual ratio of 0.85. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥541m despite its profit of CN¥768.3m, mentioned above. It's worth noting that Sinosteel Engineering & Technology generated positive FCF of CN¥1.8b a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. The good news for shareholders is that Sinosteel Engineering & Technology's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Sinosteel Engineering & Technology increased the number of shares on issue by 12% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Sinosteel Engineering & Technology's EPS by clicking here.

How Is Dilution Impacting Sinosteel Engineering & Technology's Earnings Per Share (EPS)?

As you can see above, Sinosteel Engineering & Technology has been growing its net income over the last few years, with an annualized gain of 7.3% over three years. But on the other hand, earnings per share actually fell by 0.6% per year. And over the last 12 months, the company grew its profit by 8.1%. On the other hand, earnings per share are only up 2.1% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Sinosteel Engineering & Technology 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 that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Sinosteel Engineering & Technology's Profit Performance

As it turns out, Sinosteel Engineering & Technology couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at Sinosteel Engineering & Technology's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Sinosteel Engineering & Technology as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for Sinosteel Engineering & Technology you should be mindful of and 1 of these bad boys is potentially serious.

Our examination of Sinosteel Engineering & Technology 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. 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. 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.

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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.