Following the solid earnings report from Ningbo Donly Co.,Ltd (SZSE:002164), the market responded by bidding up the stock price. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

The Impact Of Unusual Items On Profit

For anyone who wants to understand Ningbo DonlyLtd's profit beyond the statutory numbers, it's important to note that during the last twelve months statutory profit gained from CN¥8.6m worth of unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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).

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ningbo DonlyLtd.

An Unusual Tax Situation

Just as we noted the unusual items, we must inform you that Ningbo DonlyLtd received a tax benefit which contributed CN¥8.0m to the bottom line. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. Of course, prima facie it's great to receive a tax benefit. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Ningbo DonlyLtd's Profit Performance

In the last year Ningbo DonlyLtd received a tax benefit, which boosted its profit in a way that might not be much more sustainable than turning prime farmland into gas fields. 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. For the reasons mentioned above, we think that a perfunctory glance at Ningbo DonlyLtd's statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example - Ningbo DonlyLtd has 1 warning sign we think you should be aware of.

Our examination of Ningbo DonlyLtd 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 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 with high insider ownership.

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.