Despite Zhong An Intelligent Living Service Limited's (HKG:2271) recent earnings report having lackluster headline numbers, the market responded positively. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Zhong An Intelligent Living Service.

Zooming In On Zhong An Intelligent Living Service'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). 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. The ratio shows us how much a company's profit exceeds its FCF.

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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Zhong An Intelligent Living Service recorded an accrual ratio of 0.76. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of CN¥516k in the last year, which was a lot less than its statutory profit of CN¥49.3m. Given that Zhong An Intelligent Living Service had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥516k would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhong An Intelligent Living Service.

Our Take On Zhong An Intelligent Living Service's Profit Performance

As we discussed above, we think Zhong An Intelligent Living Service's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Zhong An Intelligent Living Service's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in 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'd like to know more about Zhong An Intelligent Living Service as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for Zhong An Intelligent Living Service (1 can't be ignored!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Zhong An Intelligent Living Service's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.