Hang Zhou Radical Energy-Saving Technology Co., Ltd.'s (SZSE:300652 ) stock didn't jump after it announced some healthy earnings. We did some digging and believe investors may be worried about some underlying factors in the report.

Zooming In On Hang Zhou Radical Energy-Saving Technology'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Hang Zhou Radical Energy-Saving Technology has an accrual ratio of 0.20 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of CN¥15m, in contrast to the aforementioned profit of CN¥120.4m. We saw that FCF was CN¥58m a year ago though, so Hang Zhou Radical Energy-Saving Technology has at least been able to generate positive FCF in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hang Zhou Radical Energy-Saving Technology.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Hang Zhou Radical Energy-Saving Technology's profit was boosted by unusual items worth CN¥17m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Hang Zhou Radical Energy-Saving Technology's Profit Performance

Summing up, Hang Zhou Radical Energy-Saving Technology received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Hang Zhou Radical Energy-Saving Technology's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Hang Zhou Radical Energy-Saving Technology as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for Hang Zhou Radical Energy-Saving Technology (1 makes us a bit uncomfortable!) and we strongly recommend you look at them before investing.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 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.