Hangzhou Huaguang Advanced Welding Materials Co.,Ltd. (SHSE:688379) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. However, we think that shareholders may be missing some concerning details in the numbers.

Zooming In On Hangzhou Huaguang Advanced Welding MaterialsLtd'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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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, Hangzhou Huaguang Advanced Welding MaterialsLtd recorded an accrual ratio of 0.24. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥82.9m, a look at free cash flow indicates it actually burnt through CN¥300m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥300m, this year, indicates high risk.

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 Hangzhou Huaguang Advanced Welding MaterialsLtd's Profit Performance

Hangzhou Huaguang Advanced Welding MaterialsLtd 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 Hangzhou Huaguang Advanced Welding MaterialsLtd's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 43% 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 3 warning signs for Hangzhou Huaguang Advanced Welding MaterialsLtd (2 shouldn't be ignored!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Hangzhou Huaguang Advanced Welding MaterialsLtd'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.