Hangzhou Honghua Digital Technology Stock Company LTD.'s (SHSE:688789) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Examining Cashflow Against Hangzhou Honghua Digital Technology Stock's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Hangzhou Honghua Digital Technology Stock recorded an accrual ratio of 0.30. 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¥181m despite its profit of CN¥395.9m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥181m, this year, indicates high risk.

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 Honghua Digital Technology Stock's Profit Performance

Hangzhou Honghua Digital Technology Stock'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. Because of this, we think that it may be that Hangzhou Honghua Digital Technology Stock's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 27% over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Hangzhou Honghua Digital Technology Stock, you'd also look into what risks it is currently facing. Our analysis shows 2 warning signs for Hangzhou Honghua Digital Technology Stock (1 makes us a bit uncomfortable!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Hangzhou Honghua Digital Technology Stock's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.