The latest earnings report from Diwang Industrial Holdings Limited (HKG:1950 ) disappointed investors. Our analysis suggests that while the headline numbers were soft, there are some positive factors which shareholders may have missed.
Check out our latest analysis for Diwang Industrial Holdings
Zooming In On Diwang Industrial Holdings' 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. 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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Diwang Industrial Holdings has an accrual ratio of 0.55 for the year to June 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥276m, in contrast to the aforementioned profit of CN¥11.1m. We also note that Diwang Industrial Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥276m. Having said that, there is more to the story. 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 Diwang Industrial Holdings.
The Impact Of Unusual Items On Profit
Diwang Industrial Holdings' profit suffered from unusual items, which reduced profit by CN¥4.2m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. 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. Diwang Industrial Holdings took a rather significant hit from unusual items in the year to June 2024. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.
Our Take On Diwang Industrial Holdings' Profit Performance
Diwang Industrial Holdings saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Based on these factors, it's hard to tell if Diwang Industrial Holdings' profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into Diwang Industrial Holdings, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Diwang Industrial Holdings (2 are concerning!) that we believe deserve your full attention.
Our examination of Diwang Industrial Holdings has focussed on certain factors that can make its earnings look better than they are. 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.