Despite announcing strong earnings, Shenzhen Jdd Tech New Material Co., Ltd's (SZSE:301538) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

Examining Cashflow Against Shenzhen Jdd Tech New Material'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. 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. 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 June 2024, Shenzhen Jdd Tech New Material had an accrual ratio of 0.34. 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. Even though it reported a profit of CN¥169.0m, a look at free cash flow indicates it actually burnt through CN¥37m in the last year. It's worth noting that Shenzhen Jdd Tech New Material generated positive FCF of CN¥17m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Jdd Tech New Material.

Our Take On Shenzhen Jdd Tech New Material's Profit Performance

As we have made quite clear, we're a bit worried that Shenzhen Jdd Tech New Material didn't back up the last year's profit with free cashflow. For this reason, we think that Shenzhen Jdd Tech New Material'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 on the bright side, its earnings per share have grown at an extremely impressive rate 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 Shenzhen Jdd Tech New Material, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Shenzhen Jdd Tech New Material has 2 warning signs and it would be unwise to ignore them.

This note has only looked at a single factor that sheds light on the nature of Shenzhen Jdd Tech New Material's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.