The subdued market reaction suggests that Ningbo Shimao Energy Co.,Ltd's (SHSE:605028) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

Zooming In On Ningbo Shimao EnergyLtd'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

For the year to December 2023, Ningbo Shimao EnergyLtd had an accrual ratio of 0.32. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of CN¥12m, in contrast to the aforementioned profit of CN¥188.2m. We saw that FCF was CN¥56m a year ago though, so Ningbo Shimao EnergyLtd 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 Ningbo Shimao EnergyLtd.

Our Take On Ningbo Shimao EnergyLtd's Profit Performance

As we discussed above, we think Ningbo Shimao EnergyLtd's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Ningbo Shimao EnergyLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 17% per annum growth in EPS for the last three. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Ningbo Shimao EnergyLtd has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Ningbo Shimao EnergyLtd'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 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.