A lackluster earnings announcement from ChinaEtek Service & Technology Co., Ltd. (SZSE:301208) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.
Zooming In On ChinaEtek Service & Technology'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to September 2024, ChinaEtek Service & Technology had an accrual ratio of 0.30. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥54m despite its profit of CN¥119.9m, mentioned above. We also note that ChinaEtek Service & 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¥54m.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ChinaEtek Service & Technology.
Our Take On ChinaEtek Service & Technology's Profit Performance
ChinaEtek Service & Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that ChinaEtek Service & Technology's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Case in point: We've spotted 3 warning signs for ChinaEtek Service & Technology you should be mindful of and 2 of them make us uncomfortable.
Today we've zoomed in on a single data point to better understand the nature of ChinaEtek Service & Technology'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 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.
