Shareholders didn't seem to be thrilled with Shenzhen UTIMES Intelligent Equipment Co., Ltd.'s (SHSE:688638) recent earnings report, despite healthy profit numbers. We think that they might be concerned about some underlying details that our analysis found.
View our latest analysis for Shenzhen UTIMES Intelligent Equipment
A Closer Look At Shenzhen UTIMES Intelligent Equipment's Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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. 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 September 2023, Shenzhen UTIMES Intelligent Equipment had an accrual ratio of 1.05. 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¥121m, in contrast to the aforementioned profit of CN¥78.3m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥121m, this year, indicates high risk. 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 Shenzhen UTIMES Intelligent Equipment.
The Impact Of Unusual Items On Profit
Given the accrual ratio, it's not overly surprising that Shenzhen UTIMES Intelligent Equipment's profit was boosted by unusual items worth CN¥15m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. If Shenzhen UTIMES Intelligent Equipment 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 Shenzhen UTIMES Intelligent Equipment's Profit Performance
Shenzhen UTIMES Intelligent Equipment had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shenzhen UTIMES Intelligent Equipment's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Shenzhen UTIMES Intelligent Equipment has 2 warning signs (and 1 which is significant) we think you should know about.
Our examination of Shenzhen UTIMES Intelligent Equipment 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.
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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.