Why Zhejiang Hongxin Technology's (SZSE:301539) Shaky Earnings Are Just The Beginning Of Its Problems

Last week's earnings announcement from Zhejiang Hongxin Technology Co., Ltd. (SZSE:301539) was disappointing to investors, with a sluggish profit figure. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

Check out our latest analysis for Zhejiang Hongxin Technology

Zooming In On Zhejiang Hongxin Technology's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Zhejiang Hongxin Technology has an accrual ratio of 0.44 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. Even though it reported a profit of CN¥55.3m, a look at free cash flow indicates it actually burnt through CN¥198m in the last year. We saw that FCF was CN¥67m a year ago though, so Zhejiang Hongxin Technology has at least been able to generate positive FCF in the past.

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

Our Take On Zhejiang Hongxin Technology's Profit Performance

As we have made quite clear, we're a bit worried that Zhejiang Hongxin Technology didn't back up the last year's profit with free cashflow. For this reason, we think that Zhejiang Hongxin 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. Sadly, its EPS was down over the last twelve months. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for Zhejiang Hongxin Technology (of which 1 is significant!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Hongxin Technology's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.