A lackluster earnings announcement from Zhejiang Huilong New Materials Co.,Ltd. (SZSE:301057) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

A Closer Look At Zhejiang Huilong New MaterialsLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Zhejiang Huilong New MaterialsLtd had an accrual ratio of 0.44. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥254m, in contrast to the aforementioned profit of CN¥35.7m. We also note that Zhejiang Huilong New MaterialsLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥254m.

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

Our Take On Zhejiang Huilong New MaterialsLtd's Profit Performance

As we discussed above, we think Zhejiang Huilong New MaterialsLtd'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 Zhejiang Huilong New MaterialsLtd's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Zhejiang Huilong New MaterialsLtd, you'd also look into what risks it is currently facing. Be aware that Zhejiang Huilong New MaterialsLtd is showing 3 warning signs in our investment analysis and 2 of those are potentially serious...

This note has only looked at a single factor that sheds light on the nature of Zhejiang Huilong New MaterialsLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.