Fangda Special Steel Technology Co., Ltd.'s (SHSE:600507) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

Examining Cashflow Against Fangda Special Steel Technology'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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.

Over the twelve months to June 2024, Fangda Special Steel Technology recorded an accrual ratio of -0.54. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥1.1b in the last year, which was a lot more than its statutory profit of CN¥544.7m. Fangda Special Steel Technology's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. 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.

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.

How Do Unusual Items Influence Profit?

Fangda Special Steel Technology's profit was reduced by unusual items worth CN¥90m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. 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. Assuming those unusual expenses don't come up again, we'd therefore expect Fangda Special Steel Technology to produce a higher profit next year, all else being equal.

Our Take On Fangda Special Steel Technology's Profit Performance

Considering both Fangda Special Steel Technology's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Fangda Special Steel Technology's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into Fangda Special Steel Technology, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 1 warning sign for Fangda Special Steel Technology you should know about.

Our examination of Fangda Special Steel Technology has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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.