Following the solid earnings report from Chengdu KSW Technologies Co.,Ltd. (SHSE:688283), the market responded by bidding up the stock price. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

A Closer Look At Chengdu KSW TechnologiesLtd'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Chengdu KSW TechnologiesLtd has an accrual ratio of 0.37 for the year to March 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥32m despite its profit of CN¥87.4m, mentioned above. We also note that Chengdu KSW TechnologiesLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥32m.

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 Chengdu KSW TechnologiesLtd's Profit Performance

As we discussed above, we think Chengdu KSW TechnologiesLtd's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Chengdu KSW TechnologiesLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Nonetheless, it's still worth noting that its earnings per share have grown at 68% over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Chengdu KSW TechnologiesLtd at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Chengdu KSW TechnologiesLtd.

Today we've zoomed in on a single data point to better understand the nature of Chengdu KSW TechnologiesLtd'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.