GDH Supertime Group Company Limited's (SZSE:001338) solid earnings announcement recently didn't do much to the stock price. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

A Closer Look At GDH Supertime Group'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2024, GDH Supertime Group recorded an accrual ratio of -0.61. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥2.3b in the last year, which was a lot more than its statutory profit of CN¥268.1m. GDH Supertime Group's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. 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 GDH Supertime Group.

How Do Unusual Items Influence Profit?

Surprisingly, given GDH Supertime Group's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥27m in unusual items. 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. And that's as you'd expect, given these boosts are described as 'unusual'. If GDH Supertime Group doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On GDH Supertime Group's Profit Performance

In conclusion, GDH Supertime Group's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that GDH Supertime Group's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into GDH Supertime Group, you'd also look into what risks it is currently facing. While conducting our analysis, we found that GDH Supertime Group has 1 warning sign and it would be unwise to ignore it.

Our examination of GDH Supertime Group has focussed on certain factors that can make its earnings look better than they are. 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.