Shareholders didn't seem to be thrilled with GSP Automotive Group Wenzhou Co.,Ltd.'s (SHSE:605088) recent earnings report, despite healthy profit numbers. Our analysis suggests they may be concerned about some underlying details.

Zooming In On GSP Automotive Group WenzhouLtd'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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 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.

For the year to September 2024, GSP Automotive Group WenzhouLtd had an accrual ratio of 0.49. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥351m, in contrast to the aforementioned profit of CN¥288.8m. We saw that FCF was CN¥177m a year ago though, so GSP Automotive Group WenzhouLtd has at least been able to generate positive FCF in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, GSP Automotive Group WenzhouLtd increased the number of shares on issue by 5.5% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out GSP Automotive Group WenzhouLtd's historical EPS growth by clicking on this link.

A Look At The Impact Of GSP Automotive Group WenzhouLtd's Dilution On Its Earnings Per Share (EPS)

GSP Automotive Group WenzhouLtd has improved its profit over the last three years, with an annualized gain of 174% in that time. In comparison, earnings per share only gained 163% over the same period. And over the last 12 months, the company grew its profit by 4.0%. But earnings per share are actually down 2.1%, over the last twelve months. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If GSP Automotive Group WenzhouLtd's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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 GSP Automotive Group WenzhouLtd's Profit Performance

In conclusion, GSP Automotive Group WenzhouLtd has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at GSP Automotive Group WenzhouLtd's statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Our analysis shows 3 warning signs for GSP Automotive Group WenzhouLtd (1 is significant!) and we strongly recommend you look at them before investing.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.

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.