The subdued market reaction suggests that Changzhou Shichuang Energy Co.,Ltd.'s (SHSE:688429) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

A Closer Look At Changzhou Shichuang EnergyLtd'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2024, Changzhou Shichuang EnergyLtd had an accrual ratio of 0.44. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥442m despite its profit of CN¥54.2m, mentioned above. It's worth noting that Changzhou Shichuang EnergyLtd generated positive FCF of CN¥405m a year ago, so at least they've done it in the past. The good news for shareholders is that Changzhou Shichuang EnergyLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Changzhou Shichuang EnergyLtd.

Our Take On Changzhou Shichuang EnergyLtd's Profit Performance

As we have made quite clear, we're a bit worried that Changzhou Shichuang EnergyLtd didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Changzhou Shichuang EnergyLtd's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 2 warning signs we've spotted with Changzhou Shichuang EnergyLtd (including 1 which makes us a bit uncomfortable).

This note has only looked at a single factor that sheds light on the nature of Changzhou Shichuang EnergyLtd'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.