The recent earnings posted by ZheJiang HuaSheng Technology Co.,Ltd (SHSE:605180) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

A Closer Look At ZheJiang HuaSheng TechnologyLtd'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. 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.

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.

For the year to June 2024, ZheJiang HuaSheng TechnologyLtd had an accrual ratio of 0.27. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥120m, in contrast to the aforementioned profit of CN¥41.3m. It's worth noting that ZheJiang HuaSheng TechnologyLtd generated positive FCF of CN¥79m a year ago, so at least they've done it in the past. One positive for ZheJiang HuaSheng TechnologyLtd 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ZheJiang HuaSheng TechnologyLtd.

Our Take On ZheJiang HuaSheng TechnologyLtd's Profit Performance

ZheJiang HuaSheng TechnologyLtd'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 ZheJiang HuaSheng TechnologyLtd's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased in the last year. 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 ZheJiang HuaSheng TechnologyLtd at this point in time. While conducting our analysis, we found that ZheJiang HuaSheng TechnologyLtd has 2 warning signs and it would be unwise to ignore them.

This note has only looked at a single factor that sheds light on the nature of ZheJiang HuaSheng TechnologyLtd'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.