A lackluster earnings announcement from Xinxiang Richful Lube Additive Co.,Ltd. (SZSE:300910) last week didn't sink the stock price. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

A Closer Look At Xinxiang Richful Lube AdditiveLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Xinxiang Richful Lube AdditiveLtd recorded an accrual ratio of 0.35. 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¥2.7m, in contrast to the aforementioned profit of CN¥655.7m. We saw that FCF was CN¥304m a year ago though, so Xinxiang Richful Lube AdditiveLtd has at least been able to generate positive FCF in the past.

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 Xinxiang Richful Lube AdditiveLtd's Profit Performance

As we discussed above, we think Xinxiang Richful Lube AdditiveLtd's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Xinxiang Richful Lube AdditiveLtd'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 the good news is that its EPS growth over the last three years has been very impressive. 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 Xinxiang Richful Lube AdditiveLtd, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Xinxiang Richful Lube AdditiveLtd you should be mindful of and 1 of them is significant.

This note has only looked at a single factor that sheds light on the nature of Xinxiang Richful Lube AdditiveLtd'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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.