Shareholders appeared unconcerned with Zhongyeda Electric Co., Ltd.'s (SZSE:002441) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

A Closer Look At Zhongyeda Electric'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. 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 September 2024, Zhongyeda Electric recorded an accrual ratio of -0.14. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥627m during the period, dwarfing its reported profit of CN¥130.6m. Zhongyeda Electric's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhongyeda Electric.

Our Take On Zhongyeda Electric's Profit Performance

Zhongyeda Electric's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Zhongyeda Electric's earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over 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. If you want to do dive deeper into Zhongyeda Electric, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Zhongyeda Electric (1 can't be ignored) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Zhongyeda Electric'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. 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.