Investors were disappointed by Hubei Shuanghuan Science and Technology Stock Co.,Ltd's (SZSE:000707 ) latest earnings release. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

Zooming In On Hubei Shuanghuan Science and Technology StockLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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, Hubei Shuanghuan Science and Technology StockLtd recorded an accrual ratio of 0.27. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥84m despite its profit of CN¥489.7m, mentioned above. We saw that FCF was CN¥311m a year ago though, so Hubei Shuanghuan Science and Technology StockLtd has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hubei Shuanghuan Science and Technology StockLtd.

Our Take On Hubei Shuanghuan Science and Technology StockLtd's Profit Performance

Hubei Shuanghuan Science and Technology StockLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Hubei Shuanghuan Science and Technology StockLtd'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. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 2 warning signs for Hubei Shuanghuan Science and Technology StockLtd you should be mindful of and 1 of these bad boys is a bit concerning.

This note has only looked at a single factor that sheds light on the nature of Hubei Shuanghuan Science and Technology StockLtd'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. 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.