There May Be Underlying Issues With The Quality Of Jiangsu Huachen Transformer's (SHSE:603097) Earnings

Jiangsu Huachen Transformer Co., Ltd. (SHSE:603097) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

View our latest analysis for Jiangsu Huachen Transformer

Zooming In On Jiangsu Huachen Transformer'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Jiangsu Huachen Transformer has an accrual ratio of 0.32 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥242m despite its profit of CN¥121.6m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥242m, 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 Jiangsu Huachen Transformer's Profit Performance

Jiangsu Huachen Transformer's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Jiangsu Huachen Transformer's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 15% 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. If you want to do dive deeper into Jiangsu Huachen Transformer, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 1 warning sign for Jiangsu Huachen Transformer and you'll want to know about this.

Today we've zoomed in on a single data point to better understand the nature of Jiangsu Huachen Transformer's profit. 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. 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.