The subdued market reaction suggests that GuangDong Suqun New Material Co.,Ltd.'s (SZSE:301489) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

Examining Cashflow Against GuangDong Suqun New MaterialLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to June 2024, GuangDong Suqun New MaterialLtd had an accrual ratio of 0.34. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥140m despite its profit of CN¥53.6m, mentioned above. We also note that GuangDong Suqun New MaterialLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥140m.

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 GuangDong Suqun New MaterialLtd's Profit Performance

As we have made quite clear, we're a bit worried that GuangDong Suqun New MaterialLtd didn't back up the last year's profit with free cashflow. For this reason, we think that GuangDong Suqun New MaterialLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. 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. If you want to do dive deeper into GuangDong Suqun New MaterialLtd, you'd also look into what risks it is currently facing. Be aware that GuangDong Suqun New MaterialLtd is showing 2 warning signs in our investment analysis and 1 of those is concerning...

This note has only looked at a single factor that sheds light on the nature of GuangDong Suqun New MaterialLtd'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.