Despite posting some strong earnings, the market for Zhangjiagang Furui Special Equipment Co., Ltd.'s (SZSE:300228) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

Examining Cashflow Against Zhangjiagang Furui Special Equipment'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 September 2024, Zhangjiagang Furui Special Equipment had an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥98m, in contrast to the aforementioned profit of CN¥234.3m. It's worth noting that Zhangjiagang Furui Special Equipment generated positive FCF of CN¥91m a year ago, so at least they've done it in the past. The good news for shareholders is that Zhangjiagang Furui Special Equipment's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhangjiagang Furui Special Equipment.

Our Take On Zhangjiagang Furui Special Equipment's Profit Performance

Zhangjiagang Furui Special Equipment'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. Therefore, it seems possible to us that Zhangjiagang Furui Special Equipment's true underlying earnings power is actually less than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Zhangjiagang Furui Special Equipment has 1 warning sign we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Zhangjiagang Furui Special Equipment'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.

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.