China Southern Power Grid TechnologyLtd's (SHSE:688248) Solid Earnings Have Been Accounted For Conservatively

The market seemed underwhelmed by last week's earnings announcement from China Southern Power Grid Technology Co.,Ltd (SHSE:688248) despite the healthy numbers. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

See our latest analysis for China Southern Power Grid TechnologyLtd

A Closer Look At China Southern Power Grid TechnologyLtd'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 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.

Over the twelve months to December 2023, China Southern Power Grid TechnologyLtd recorded an accrual ratio of -0.46. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥398m during the period, dwarfing its reported profit of CN¥281.3m. China Southern Power Grid TechnologyLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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 China Southern Power Grid TechnologyLtd's Profit Performance

As we discussed above, China Southern Power Grid TechnologyLtd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think China Southern Power Grid TechnologyLtd's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing China Southern Power Grid TechnologyLtd at this point in time. You'd be interested to know, that we found 1 warning sign for China Southern Power Grid TechnologyLtd and you'll want to know about this.

Today we've zoomed in on a single data point to better understand the nature of China Southern Power Grid TechnologyLtd'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. 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 that insiders are buying 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.