The subdued stock price reaction suggests that Wuxi DK Electronic Materials Co.,Ltd.'s (SZSE:300842) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

A Closer Look At Wuxi DK Electronic MaterialsLtd'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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

Wuxi DK Electronic MaterialsLtd has an accrual ratio of 0.24 for the year to June 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥44m despite its profit of CN¥415.8m, mentioned above. We also note that Wuxi DK Electronic MaterialsLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥44m. 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.

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.

The Impact Of Unusual Items On Profit

Wuxi DK Electronic MaterialsLtd's profit suffered from unusual items, which reduced profit by CN¥194m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If Wuxi DK Electronic MaterialsLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Wuxi DK Electronic MaterialsLtd's Profit Performance

In conclusion, Wuxi DK Electronic MaterialsLtd's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Based on these factors, it's hard to tell if Wuxi DK Electronic MaterialsLtd's profits are a reasonable reflection of its underlying profitability. If you'd like to know more about Wuxi DK Electronic MaterialsLtd as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for Wuxi DK Electronic MaterialsLtd you should be mindful of and 1 of them shouldn't be ignored.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 with significant insider holdings 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.