Following the solid earnings report from Nanjing CIGU Technology Corp.,LTD. (SHSE:688448), the market responded by bidding up the stock price. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

Zooming In On Nanjing CIGU 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2024, Nanjing CIGU TechnologyLTD had an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥46m despite its profit of CN¥50.0m, mentioned above. We also note that Nanjing CIGU TechnologyLTD's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥46m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nanjing CIGU TechnologyLTD.

Our Take On Nanjing CIGU TechnologyLTD's Profit Performance

Nanjing CIGU TechnologyLTD didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Nanjing CIGU TechnologyLTD's true underlying earnings power is actually less than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for Nanjing CIGU TechnologyLTD (of which 1 can't be ignored!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Nanjing CIGU 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 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.