Hangzhou EZVIZ Network Co., Ltd. (SHSE:688475) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

A Closer Look At Hangzhou EZVIZ Network'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. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Hangzhou EZVIZ Network has an accrual ratio of 0.61 for the year to March 2024. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥24m despite its profit of CN¥597.0m, mentioned above. We saw that FCF was CN¥407m a year ago though, so Hangzhou EZVIZ Network has at least been able to generate positive FCF in the past. One positive for Hangzhou EZVIZ Network shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Hangzhou EZVIZ Network's Profit Performance

As we have made quite clear, we're a bit worried that Hangzhou EZVIZ Network didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Hangzhou EZVIZ Network's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 33% per annum growth in EPS for the last three. 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. If you'd like to know more about Hangzhou EZVIZ Network as a business, it's important to be aware of any risks it's facing. Be aware that Hangzhou EZVIZ Network is showing 2 warning signs in our investment analysis and 1 of those can't be ignored...

This note has only looked at a single factor that sheds light on the nature of Hangzhou EZVIZ Network's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.