Winstech Precision Holding Co., LTD. (SZSE:001319) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

A Closer Look At Winstech Precision Holding'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. 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'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Winstech Precision Holding has an accrual ratio of 0.24 for the year to September 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥107.1m, a look at free cash flow indicates it actually burnt through CN¥81m in the last year. It's worth noting that Winstech Precision Holding generated positive FCF of CN¥68m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Winstech Precision Holding.

Our Take On Winstech Precision Holding's Profit Performance

Winstech Precision Holding'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 Winstech Precision Holding's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 27% 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 Winstech Precision Holding at this point in time. For example, we've found that Winstech Precision Holding has 2 warning signs (1 is significant!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Winstech Precision Holding'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.

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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.