A lackluster earnings announcement from Shanghai HYP-ARCH Architectural Design Consultant Co.,Ltd. (SZSE:301024) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Shanghai HYP-ARCH Architectural Design ConsultantLtd

Zooming In On Shanghai HYP-ARCH Architectural Design ConsultantLtd'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). 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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 December 2021, Shanghai HYP-ARCH Architectural Design ConsultantLtd had an accrual ratio of 0.32. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of CN¥46.9m, a look at free cash flow indicates it actually burnt through CN¥71m in the last year. We also note that Shanghai HYP-ARCH Architectural Design ConsultantLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥71m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanghai HYP-ARCH Architectural Design ConsultantLtd.

Our Take On Shanghai HYP-ARCH Architectural Design ConsultantLtd's Profit Performance

Shanghai HYP-ARCH Architectural Design ConsultantLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Shanghai HYP-ARCH Architectural Design ConsultantLtd's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Shanghai HYP-ARCH Architectural Design ConsultantLtd has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Shanghai HYP-ARCH Architectural Design ConsultantLtd's 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 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.