The market for Zhejiang Hengwei Battery Co., Ltd.'s (SZSE:301222) stock was strong after it released a healthy earnings report last week. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

A Closer Look At Zhejiang Hengwei Battery'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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.

Zhejiang Hengwei Battery has an accrual ratio of 0.50 for the year to March 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥23m, in contrast to the aforementioned profit of CN¥130.4m. It's worth noting that Zhejiang Hengwei Battery generated positive FCF of CN¥109m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Hengwei Battery.

Our Take On Zhejiang Hengwei Battery's Profit Performance

As we discussed above, we think Zhejiang Hengwei Battery's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Zhejiang Hengwei Battery's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. And we are pleased to note that EPS is at least heading in the right direction in the alst twelve months. 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. If you'd like to know more about Zhejiang Hengwei Battery as a business, it's important to be aware of any risks it's facing. When we did our research, we found 2 warning signs for Zhejiang Hengwei Battery (1 makes us a bit uncomfortable!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Hengwei Battery'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.