Suzhou Hesheng Special Material Co., Ltd. (SZSE:002290) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.

Examining Cashflow Against Suzhou Hesheng Special Material's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

Suzhou Hesheng Special Material has an accrual ratio of -0.20 for the year to December 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥223m during the period, dwarfing its reported profit of CN¥82.8m. Suzhou Hesheng Special Material's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Suzhou Hesheng Special Material.

Our Take On Suzhou Hesheng Special Material's Profit Performance

Happily for shareholders, Suzhou Hesheng Special Material produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Suzhou Hesheng Special Material's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 43% per year 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. If you want to do dive deeper into Suzhou Hesheng Special Material, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Suzhou Hesheng Special Material, and understanding this should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Suzhou Hesheng Special Material's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.