Zhejiang Asia-Pacific Mechanical & Electronic Co.,Ltd (SZSE:002284) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

A Closer Look At Zhejiang Asia-Pacific Mechanical & ElectronicLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Zhejiang Asia-Pacific Mechanical & ElectronicLtd has an accrual ratio of -0.41 for the year to September 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥875m during the period, dwarfing its reported profit of CN¥156.7m. Zhejiang Asia-Pacific Mechanical & ElectronicLtd 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 Zhejiang Asia-Pacific Mechanical & ElectronicLtd.

Our Take On Zhejiang Asia-Pacific Mechanical & ElectronicLtd's Profit Performance

Happily for shareholders, Zhejiang Asia-Pacific Mechanical & ElectronicLtd produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Zhejiang Asia-Pacific Mechanical & ElectronicLtd's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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'd like to know more about Zhejiang Asia-Pacific Mechanical & ElectronicLtd as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Zhejiang Asia-Pacific Mechanical & ElectronicLtd, 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 Zhejiang Asia-Pacific Mechanical & ElectronicLtd's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.