Last week's profit announcement from Smartsens Technology (Shanghai) Co., Ltd. (SHSE:688213) was underwhelming for investors, despite headline numbers being robust. We think that the market might be paying attention to some underlying factors that they find to be concerning.

A Closer Look At Smartsens Technology (Shanghai)'s Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to June 2024, Smartsens Technology (Shanghai) recorded an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥230.4m, a look at free cash flow indicates it actually burnt through CN¥794m in the last year. We also note that Smartsens Technology (Shanghai)'s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥794m. One positive for Smartsens Technology (Shanghai) shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Smartsens Technology (Shanghai)'s Profit Performance

Smartsens Technology (Shanghai)'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. Therefore, it seems possible to us that Smartsens Technology (Shanghai)'s true underlying earnings power is actually less than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. If you'd like to know more about Smartsens Technology (Shanghai) as a business, it's important to be aware of any risks it's facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Smartsens Technology (Shanghai).

This note has only looked at a single factor that sheds light on the nature of Smartsens Technology (Shanghai)'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. 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 with significant insider holdings 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.