Concerns Surrounding Hang Zhou Radical Energy-Saving Technology's (SZSE:300652) Performance

The stock price didn't jump after Hang Zhou Radical Energy-Saving Technology Co., Ltd. (SZSE:300652) posted decent earnings last week. We did some digging and believe investors may be worried about some underlying factors in the report.

View our latest analysis for Hang Zhou Radical Energy-Saving Technology

A Closer Look At Hang Zhou Radical Energy-Saving 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Hang Zhou Radical Energy-Saving Technology has an accrual ratio of 0.20 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥15m, in contrast to the aforementioned profit of CN¥120.4m. It's worth noting that Hang Zhou Radical Energy-Saving Technology generated positive FCF of CN¥58m a year ago, so at least they've done it in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hang Zhou Radical Energy-Saving Technology.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥17m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Hang Zhou Radical Energy-Saving Technology's Profit Performance

Hang Zhou Radical Energy-Saving Technology had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Hang Zhou Radical Energy-Saving Technology's profits probably give an overly generous impression of its sustainable level of profitability. 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. Be aware that Hang Zhou Radical Energy-Saving Technology is showing 3 warning signs in our investment analysis and 1 of those can't be ignored...

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.