The subdued market reaction suggests that Anhui Shunyu Water Affairs Co.,Ltd.'s (SZSE:301519) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

A Closer Look At Anhui Shunyu Water AffairsLtd's 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Anhui Shunyu Water AffairsLtd has an accrual ratio of 0.22 for the year to March 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥294m despite its profit of CN¥68.7m, mentioned above. We also note that Anhui Shunyu Water AffairsLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥294m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Anhui Shunyu Water AffairsLtd.

Our Take On Anhui Shunyu Water AffairsLtd's Profit Performance

Anhui Shunyu Water AffairsLtd'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 Anhui Shunyu Water AffairsLtd's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Anhui Shunyu Water AffairsLtd at this point in time. In terms of investment risks, we've identified 1 warning sign with Anhui Shunyu Water AffairsLtd, and understanding it should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Anhui Shunyu Water AffairsLtd's profit. 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 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.