Erayak Power Solution Group Inc.'s (NASDAQ:RAYA) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. We think that investors might be looking at some positive factors beyond the earnings numbers.

A Closer Look At Erayak Power Solution Group'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2023, Erayak Power Solution Group recorded an accrual ratio of -0.23. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of US$6.0m during the period, dwarfing its reported profit of US$1.22m. Notably, Erayak Power Solution Group had negative free cash flow last year, so the US$6.0m it produced this year was a welcome improvement.

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 Erayak Power Solution Group's Profit Performance

As we discussed above, Erayak Power Solution Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Erayak Power Solution Group's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 4 warning signs for Erayak Power Solution Group (3 are a bit unpleasant) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Erayak Power Solution Group'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 that insiders are buying.

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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.