Soft earnings didn't appear to concern Hebei Yangyuan ZhiHui Beverage Co., Ltd.'s (SHSE:603156) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

Examining Cashflow Against Hebei Yangyuan ZhiHui Beverage'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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Hebei Yangyuan ZhiHui Beverage has an accrual ratio of -0.19 for the year to September 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥2.3b during the period, dwarfing its reported profit of CN¥1.41b. Hebei Yangyuan ZhiHui Beverage shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hebei Yangyuan ZhiHui Beverage.

Our Take On Hebei Yangyuan ZhiHui Beverage's Profit Performance

Happily for shareholders, Hebei Yangyuan ZhiHui Beverage produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Hebei Yangyuan ZhiHui Beverage's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over 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. Every company has risks, and we've spotted 2 warning signs for Hebei Yangyuan ZhiHui Beverage (of which 1 is a bit unpleasant!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Hebei Yangyuan ZhiHui Beverage's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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.