Xiamen King Long Motor Group Co., Ltd. (SHSE:600686) just released a solid earnings report, and the stock displayed some strength. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

A Closer Look At Xiamen King Long Motor 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Xiamen King Long Motor Group has an accrual ratio of -0.50 for the year to June 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥1.1b, well over the CN¥94.6m it reported in profit. Xiamen King Long Motor Group's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Xiamen King Long Motor Group.

How Do Unusual Items Influence Profit?

Surprisingly, given Xiamen King Long Motor Group's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥328m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. We can see that Xiamen King Long Motor Group's positive unusual items were quite significant relative to its profit in the year to June 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Xiamen King Long Motor Group's Profit Performance

Xiamen King Long Motor Group's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if Xiamen King Long Motor Group's profits are a reasonable reflection of its underlying profitability. 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. Case in point: We've spotted 3 warning signs for Xiamen King Long Motor Group you should be mindful of and 2 of them can't be ignored.

Our examination of Xiamen King Long Motor Group has focussed on certain factors that can make its earnings look better than they are. 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.

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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.