The market for Shandong Hiking International Co.,Ltd's (SHSE:600735) shares didn't move much after it posted weak earnings recently. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Zooming In On Shandong Hiking InternationalLtd'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). 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.

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.

Over the twelve months to June 2024, Shandong Hiking InternationalLtd recorded an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of CN¥167m during the period, dwarfing its reported profit of CN¥41.2m. Shandong Hiking InternationalLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shandong Hiking InternationalLtd.

Our Take On Shandong Hiking InternationalLtd's Profit Performance

As we discussed above, Shandong Hiking InternationalLtd has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Shandong Hiking InternationalLtd's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 2 warning signs for Shandong Hiking InternationalLtd (1 is significant) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Shandong Hiking InternationalLtd'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 with high insider ownership.

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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.