We Think That There Are Some Issues For Wetown Electric Group (SHSE:688226) Beyond Its Promising Earnings

The stock price didn't jump after Wetown Electric Group Co., Ltd. (SHSE:688226) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.

Check out our latest analysis for Wetown Electric Group

Examining Cashflow Against Wetown Electric Group'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Wetown Electric Group has an accrual ratio of 0.26 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥144.7m, a look at free cash flow indicates it actually burnt through CN¥409m in the last year. We also note that Wetown Electric Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥409m.

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 Wetown Electric Group's Profit Performance

Wetown Electric Group didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Wetown Electric Group's true underlying earnings power is actually less than its statutory profit. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 3 warning signs for Wetown Electric Group (2 are concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Wetown Electric Group'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. 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.