Despite posting some strong earnings, the market for Sichuan Swellfun Co.,Ltd's (SHSE:600779) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.
Zooming In On Sichuan SwellfunLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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.
Sichuan SwellfunLtd has an accrual ratio of 0.22 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. To wit, it produced free cash flow of CN¥789m during the period, falling well short of its reported profit of CN¥1.30b. Notably, Sichuan SwellfunLtd had negative free cash flow last year, so the CN¥789m it produced this year was a welcome improvement.
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.
Our Take On Sichuan SwellfunLtd's Profit Performance
Sichuan SwellfunLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Sichuan SwellfunLtd's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 35% over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 2 warning signs for Sichuan SwellfunLtd (of which 1 is concerning!) you should know about.
This note has only looked at a single factor that sheds light on the nature of Sichuan SwellfunLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying.
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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.