Despite posting some strong earnings, the market for EIT Environmental Development Group Co.,Ltd's (SZSE:300815) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for EIT Environmental Development GroupLtd

Zooming In On EIT Environmental Development GroupLtd'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. 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.

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. 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.

EIT Environmental Development GroupLtd has an accrual ratio of 0.22 for the year to September 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥572.6m, a look at free cash flow indicates it actually burnt through CN¥248m in the last year. It's worth noting that EIT Environmental Development GroupLtd generated positive FCF of CN¥9.9m a year ago, so at least they've done it in the past.

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 EIT Environmental Development GroupLtd's Profit Performance

EIT Environmental Development GroupLtd'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 EIT Environmental Development GroupLtd's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 33% in the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing EIT Environmental Development GroupLtd at this point in time. To that end, you should learn about the 2 warning signs we've spotted with EIT Environmental Development GroupLtd (including 1 which makes us a bit uncomfortable).

Today we've zoomed in on a single data point to better understand the nature of EIT Environmental Development GroupLtd'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.