Jiangsu Newamstar Packaging Machinery Co.,Ltd's (SZSE:300509) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

Zooming In On Jiangsu Newamstar Packaging MachineryLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to June 2024, Jiangsu Newamstar Packaging MachineryLtd had an accrual ratio of -0.15. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥71m during the period, dwarfing its reported profit of CN¥21.1m. Notably, Jiangsu Newamstar Packaging MachineryLtd had negative free cash flow last year, so the CN¥71m it produced this year was a welcome improvement. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jiangsu Newamstar Packaging MachineryLtd.

The Impact Of Unusual Items On Profit

Jiangsu Newamstar Packaging MachineryLtd's profit was reduced by unusual items worth CN¥13m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Jiangsu Newamstar Packaging MachineryLtd to produce a higher profit next year, all else being equal.

Our Take On Jiangsu Newamstar Packaging MachineryLtd's Profit Performance

In conclusion, both Jiangsu Newamstar Packaging MachineryLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Jiangsu Newamstar Packaging MachineryLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For instance, we've identified 3 warning signs for Jiangsu Newamstar Packaging MachineryLtd (1 is concerning) you should be familiar with.

After our examination into the nature of Jiangsu Newamstar Packaging MachineryLtd's profit, we've come away optimistic for the company. But there are plenty of other ways to inform your opinion of a company. 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.

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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.