The subdued market reaction suggests that Nanjing Wavelength Opto-Electronic Science & Technology Co.,Ltd.'s (SZSE:301421) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

Zooming In On Nanjing Wavelength Opto-Electronic Science & TechnologyLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Nanjing Wavelength Opto-Electronic Science & TechnologyLtd recorded an accrual ratio of 0.39. 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¥133m despite its profit of CN¥42.3m, mentioned above. We also note that Nanjing Wavelength Opto-Electronic Science & TechnologyLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥133m.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Nanjing Wavelength Opto-Electronic Science & TechnologyLtd's Profit Performance

As we discussed above, we think Nanjing Wavelength Opto-Electronic Science & TechnologyLtd'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 Nanjing Wavelength Opto-Electronic Science & TechnologyLtd's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Nanjing Wavelength Opto-Electronic Science & TechnologyLtd at this point in time. To help with this, we've discovered 3 warning signs (2 are a bit unpleasant!) that you ought to be aware of before buying any shares in Nanjing Wavelength Opto-Electronic Science & TechnologyLtd.

This note has only looked at a single factor that sheds light on the nature of Nanjing Wavelength Opto-Electronic Science & TechnologyLtd'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.