The latest earnings report from Jiangsu Tongda Power Technology Co.,Ltd. (SZSE:002576 ) disappointed investors. We did some digging and believe that things are better than they seem due to some encouraging factors.

Examining Cashflow Against Jiangsu Tongda Power TechnologyLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Jiangsu Tongda Power TechnologyLtd recorded an accrual ratio of -0.24. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of CN¥286m, well over the CN¥58.6m it reported in profit. Given that Jiangsu Tongda Power TechnologyLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥286m would seem to be a step in the right direction. However, that's not all there is to consider. 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 Jiangsu Tongda Power TechnologyLtd.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Jiangsu Tongda Power TechnologyLtd's profit was boosted by unusual items worth CN¥20m in the last twelve months. 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. We can see that Jiangsu Tongda Power TechnologyLtd's positive unusual items were quite significant relative to its profit in the year to September 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 Jiangsu Tongda Power TechnologyLtd's Profit Performance

In conclusion, Jiangsu Tongda Power TechnologyLtd'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, it's hard to tell if Jiangsu Tongda Power TechnologyLtd's profits are a reasonable reflection of its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Jiangsu Tongda Power TechnologyLtd.

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. Some people consider a high return on equity to be a good sign of a quality business. 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.