Sinosteel Engineering & Technology Co., Ltd.'s (SZSE:000928) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

A Closer Look At Sinosteel Engineering & Technology'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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Sinosteel Engineering & Technology had an accrual ratio of 0.83. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥910.6m, a look at free cash flow indicates it actually burnt through CN¥1.7b in the last year. We saw that FCF was CN¥2.7b a year ago though, so Sinosteel Engineering & Technology has at least been able to generate positive FCF in the past. The good news for shareholders is that Sinosteel Engineering & Technology's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current 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 Sinosteel Engineering & Technology's Profit Performance

As we have made quite clear, we're a bit worried that Sinosteel Engineering & Technology didn't back up the last year's profit with free cashflow. For this reason, we think that Sinosteel Engineering & Technology's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 16% in 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. Our analysis shows 2 warning signs for Sinosteel Engineering & Technology (1 doesn't sit too well with us!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Sinosteel Engineering & Technology'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.