CCCC Design & Consulting Group Co., Ltd. (SHSE:600720) posted some decent earnings, but shareholders didn't react strongly. Our analysis has found some concerning factors which weaken the profit's foundation.

Zooming In On CCCC Design & Consulting Group'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

CCCC Design & Consulting Group has an accrual ratio of 0.45 for the year to September 2024. 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. Even though it reported a profit of CN¥1.98b, a look at free cash flow indicates it actually burnt through CN¥1.9b in the last year. We saw that FCF was CN¥113m a year ago though, so CCCC Design & Consulting Group has at least been able to generate positive FCF in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. CCCC Design & Consulting Group expanded the number of shares on issue by 196% over the last year. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out CCCC Design & Consulting Group's historical EPS growth by clicking on this link.

A Look At The Impact Of CCCC Design & Consulting Group's Dilution On Its Earnings Per Share (EPS)

As you can see above, CCCC Design & Consulting Group has been growing its net income over the last few years, with an annualized gain of 110% over three years. But on the other hand, earnings per share actually fell by 21% per year. And the 22% profit boost in the last year certainly seems impressive at first glance. But earnings per share are actually down 9.0%, over the last twelve months. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If CCCC Design & Consulting Group's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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 CCCC Design & Consulting Group's Profit Performance

In conclusion, CCCC Design & Consulting Group 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). On reflection, the above-mentioned factors give us the strong impression that CCCC Design & Consulting Group'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 3 warning signs for CCCC Design & Consulting Group you should be mindful of and 2 of these bad boys are potentially serious.

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. 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.