The market seemed underwhelmed by the solid earnings posted by China Display Optoelectronics Technology Holdings Limited (HKG:334) recently. Our analysis suggests that there are some reasons for hope that investors should be aware of.

Zooming In On China Display Optoelectronics Technology Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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. 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.

Over the twelve months to June 2024, China Display Optoelectronics Technology Holdings recorded an accrual ratio of -0.59. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥402m during the period, dwarfing its reported profit of CN¥27.5m. Notably, China Display Optoelectronics Technology Holdings had negative free cash flow last year, so the CN¥402m it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Display Optoelectronics Technology Holdings.

Our Take On China Display Optoelectronics Technology Holdings' Profit Performance

Happily for shareholders, China Display Optoelectronics Technology Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think China Display Optoelectronics Technology Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 2 warning signs for China Display Optoelectronics Technology Holdings (1 is a bit concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of China Display Optoelectronics Technology Holdings' 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 with significant insider holdings 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.