Shenzhen Laibao Hi-Tech Co., Ltd.'s (SZSE:002106) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We have done some analysis and have found some comforting factors beneath the profit numbers.

Zooming In On Shenzhen Laibao Hi-Tech'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

Shenzhen Laibao Hi-Tech has an accrual ratio of -0.14 for the year to June 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥557m during the period, dwarfing its reported profit of CN¥389.5m. Shenzhen Laibao Hi-Tech's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Laibao Hi-Tech.

Our Take On Shenzhen Laibao Hi-Tech's Profit Performance

Shenzhen Laibao Hi-Tech's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Shenzhen Laibao Hi-Tech's earnings potential is at least as good as it seems, and maybe even better! And the EPS is up 22% 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Every company has risks, and we've spotted 1 warning sign for Shenzhen Laibao Hi-Tech you should know about.

This note has only looked at a single factor that sheds light on the nature of Shenzhen Laibao Hi-Tech's profit. 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.