There May Be Underlying Issues With The Quality Of Zhejiang Songyuan Automotive Safety SystemsLtd's (SZSE:300893) Earnings

Zhejiang Songyuan Automotive Safety Systems Co.,Ltd. (SZSE:300893) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

See our latest analysis for Zhejiang Songyuan Automotive Safety SystemsLtd

Zooming In On Zhejiang Songyuan Automotive Safety SystemsLtd'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. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Zhejiang Songyuan Automotive Safety SystemsLtd has an accrual ratio of 0.39 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥348m, in contrast to the aforementioned profit of CN¥271.4m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥348m, 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 Zhejiang Songyuan Automotive Safety SystemsLtd's Profit Performance

As we discussed above, we think Zhejiang Songyuan Automotive Safety SystemsLtd's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Zhejiang Songyuan Automotive Safety SystemsLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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. Every company has risks, and we've spotted 3 warning signs for Zhejiang Songyuan Automotive Safety SystemsLtd (of which 1 doesn't sit too well with us!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Songyuan Automotive Safety SystemsLtd'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. 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.