Guangzhou Tech-Long Packaging Machinery Co.,Ltd.'s (SZSE:002209) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We have done some analysis and have found some comforting factors beneath the profit numbers.

A Closer Look At Guangzhou Tech-Long Packaging MachineryLtd'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. 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.

Over the twelve months to September 2024, Guangzhou Tech-Long Packaging MachineryLtd recorded an accrual ratio of -0.49. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥227m in the last year, which was a lot more than its statutory profit of CN¥40.8m. Guangzhou Tech-Long Packaging MachineryLtd's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. 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 Guangzhou Tech-Long Packaging MachineryLtd.

The Impact Of Unusual Items On Profit

Surprisingly, given Guangzhou Tech-Long Packaging MachineryLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥6.7m in unusual items. 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. And that's as you'd expect, given these boosts are described as 'unusual'. If Guangzhou Tech-Long Packaging MachineryLtd 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 Guangzhou Tech-Long Packaging MachineryLtd's Profit Performance

In conclusion, Guangzhou Tech-Long Packaging MachineryLtd's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think that Guangzhou Tech-Long Packaging MachineryLtd's profits are a reasonably conservative guide to its underlying profitability. While earnings are important, another area to consider is the balance sheet. We've done some analysis and you can see our take on Guangzhou Tech-Long Packaging MachineryLtd's balance sheet by clicking here.

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.