Even though CITIC Metal Co., Ltd (SHSE:601061) posted strong earnings recently, the stock hasn't reacted in a large way. We decided to have a deeper look, and we believe that investors might be worried about several concerning factors that we found.

Zooming In On CITIC Metal'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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 September 2024, CITIC Metal recorded an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥4.7b, in contrast to the aforementioned profit of CN¥2.20b. It's worth noting that CITIC Metal generated positive FCF of CN¥2.5b a year ago, so at least they've done it in the past. 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. One positive for CITIC Metal shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that CITIC Metal's profit was boosted by unusual items worth CN¥522m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. We can see that CITIC Metal's positive unusual items were quite significant relative to its profit in the year to September 2024. 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 CITIC Metal's Profit Performance

CITIC Metal had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue CITIC Metal's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing CITIC Metal at this point in time. When we did our research, we found 3 warning signs for CITIC Metal (2 are concerning!) that we believe deserve your full attention.

Our examination of CITIC Metal 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. 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.

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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.