After announcing weak earnings, Shanghai V-Test Semiconductor Tech. Co., Ltd.'s (SHSE:688372) stock was strong. While shares were up, we believe there are some factors in the earnings report that might cause investors some concerns.

Examining Cashflow Against Shanghai V-Test Semiconductor Tech'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 September 2024, Shanghai V-Test Semiconductor Tech recorded an accrual ratio of 0.31. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of CN¥90.4m, a look at free cash flow indicates it actually burnt through CN¥892m in the last year. We also note that Shanghai V-Test Semiconductor Tech's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥892m. Having said that it seems that a recent tax benefit and some unusual items have impacted its profit (and this its 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

The fact that the company had unusual items boosting profit by CN¥14m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Shanghai V-Test Semiconductor Tech doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Shanghai V-Test Semiconductor Tech profited from a tax benefit which contributed CN¥7.9m to profit. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! Of course, prima facie it's great to receive a tax benefit. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal.

Our Take On Shanghai V-Test Semiconductor Tech's Profit Performance

Summing up, Shanghai V-Test Semiconductor Tech's tax benefit and unusual items boosted its statutory profit leading to poor cash conversion, as reflected by its accrual ratio. For the reasons mentioned above, we think that a perfunctory glance at Shanghai V-Test Semiconductor Tech's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Shanghai V-Test Semiconductor Tech as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 4 warning signs (2 are concerning!) that you ought to be aware of before buying any shares in Shanghai V-Test Semiconductor Tech.

Our examination of Shanghai V-Test Semiconductor Tech 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 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. 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.