Zhejiang Zomax Transmission's (SHSE:603767) Conservative Accounting Might Explain Soft Earnings

Zhejiang Zomax Transmission Co., Ltd.'s (SHSE:603767) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

Check out our latest analysis for Zhejiang Zomax Transmission

A Closer Look At Zhejiang Zomax Transmission'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.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2024, Zhejiang Zomax Transmission recorded an accrual ratio of -0.10. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥162m, well over the CN¥56.8m it reported in profit. Zhejiang Zomax Transmission shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Zomax Transmission.

Our Take On Zhejiang Zomax Transmission's Profit Performance

As we discussed above, Zhejiang Zomax Transmission has perfectly satisfactory free cash flow relative to profit. Because of this, we think Zhejiang Zomax Transmission's earnings potential is at least as good as it seems, and maybe even better! And it's also good to see that its earnings per share have improved a bit over the last three years. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. While conducting our analysis, we found that Zhejiang Zomax Transmission has 1 warning sign and it would be unwise to ignore it.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Zomax Transmission'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.

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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.