The market shrugged off Zhejiang Tongxing Technology CO., Ltd.'s (SZSE:301252) solid earnings report. We did some digging and believe investors may be worried about some underlying factors in the report.

Examining Cashflow Against Zhejiang Tongxing Technology'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). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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. 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 June 2024, Zhejiang Tongxing Technology recorded 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¥10m despite its profit of CN¥122.4m, mentioned above. We also note that Zhejiang Tongxing Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥10m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Tongxing Technology.

Our Take On Zhejiang Tongxing Technology's Profit Performance

Zhejiang Tongxing Technology'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 Zhejiang Tongxing Technology's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 39% per annum growth in EPS for the last three. 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 while earnings quality is important, it's equally important to consider the risks facing Zhejiang Tongxing Technology at this point in time. To that end, you should learn about the 3 warning signs we've spotted with Zhejiang Tongxing Technology (including 2 which are potentially serious).

This note has only looked at a single factor that sheds light on the nature of Zhejiang Tongxing Technology'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.