Jiangsu Hengli Hydraulic Co.,Ltd's (SHSE:601100) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Examining Cashflow Against Jiangsu Hengli HydraulicLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Jiangsu Hengli HydraulicLtd has an accrual ratio of 0.21 for the year to September 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In fact, it had free cash flow of CN¥1.2b in the last year, which was a lot less than its statutory profit of CN¥2.54b. We note, however, that Jiangsu Hengli HydraulicLtd grew its free cash flow over the last year.

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 Jiangsu Hengli HydraulicLtd's Profit Performance

Jiangsu Hengli HydraulicLtd 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 Jiangsu Hengli HydraulicLtd's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 7.4% EPS growth in the 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. So while earnings quality is important, it's equally important to consider the risks facing Jiangsu Hengli HydraulicLtd at this point in time. Be aware that Jiangsu Hengli HydraulicLtd is showing 2 warning signs in our investment analysis and 1 of those can't be ignored...

This note has only looked at a single factor that sheds light on the nature of Jiangsu Hengli HydraulicLtd'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. 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.