The recent earnings posted by Zhejiang Wandekai Fluid Equipment Technology Co., Ltd. (SZSE:301309) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

A Closer Look At Zhejiang Wandekai Fluid Equipment Technology's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Zhejiang Wandekai Fluid Equipment Technology has an accrual ratio of 0.30 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of CN¥145.9m, a look at free cash flow indicates it actually burnt through CN¥167m in the last year. We also note that Zhejiang Wandekai Fluid Equipment Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥167m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Wandekai Fluid Equipment Technology.

Our Take On Zhejiang Wandekai Fluid Equipment Technology's Profit Performance

Zhejiang Wandekai Fluid Equipment Technology'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 Zhejiang Wandekai Fluid Equipment Technology's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 12% per annum growth in EPS for the last three. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Zhejiang Wandekai Fluid Equipment Technology, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Zhejiang Wandekai Fluid Equipment Technology you should be mindful of and 1 of them is a bit concerning.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Wandekai Fluid Equipment Technology'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.