The subdued market reaction suggests that Hwaxin Environmental Co.,Ltd.'s (SZSE:301265) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

Check out our latest analysis for Hwaxin EnvironmentalLtd

Zooming In On Hwaxin EnvironmentalLtd'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. 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. 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 September 2023, Hwaxin EnvironmentalLtd had an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥118m despite its profit of CN¥96.4m, mentioned above. We saw that FCF was CN¥40m a year ago though, so Hwaxin EnvironmentalLtd 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 Hwaxin EnvironmentalLtd.

Our Take On Hwaxin EnvironmentalLtd's Profit Performance

Hwaxin EnvironmentalLtd 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 Hwaxin EnvironmentalLtd'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. So while earnings quality is important, it's equally important to consider the risks facing Hwaxin EnvironmentalLtd at this point in time. Every company has risks, and we've spotted 2 warning signs for Hwaxin EnvironmentalLtd (of which 1 makes us a bit uncomfortable!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Hwaxin EnvironmentalLtd'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. 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 that insiders are buying 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.