Soft earnings didn't appear to concern Shenzhen Huijie Group Co., Ltd.'s (SZSE:002763) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for Shenzhen Huijie Group

Zooming In On Shenzhen Huijie Group'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. 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.

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 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".

Over the twelve months to March 2022, Shenzhen Huijie Group recorded an accrual ratio of -0.14. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. Indeed, in the last twelve months it reported free cash flow of CN¥412m, well over the CN¥252.1m it reported in profit. Over the last year, Shenzhen Huijie Group's free cash flow remained steady.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Huijie Group.

Our Take On Shenzhen Huijie Group's Profit Performance

Shenzhen Huijie Group's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Shenzhen Huijie Group's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 39% per year over the last three years. 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 while earnings quality is important, it's equally important to consider the risks facing Shenzhen Huijie Group at this point in time. Every company has risks, and we've spotted 1 warning sign for Shenzhen Huijie Group you should know about.

This note has only looked at a single factor that sheds light on the nature of Shenzhen Huijie Group'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 that insiders are buying 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.