Earnings Troubles May Signal Larger Issues for Shanghai CEO Environmental Protection Technology (SHSE:688335) Shareholders

Shanghai CEO Environmental Protection Technology Co., Ltd's (SHSE:688335) stock showed strength, with investors undeterred by its weak earnings report. We think that shareholders might be missing some concerning factors that our analysis found.

Check out our latest analysis for Shanghai CEO Environmental Protection Technology

Examining Cashflow Against Shanghai CEO Environmental Protection 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Shanghai CEO Environmental Protection Technology recorded an accrual ratio of 0.51. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥158m despite its profit of CN¥100.0m, mentioned above. We saw that FCF was CN¥60m a year ago though, so Shanghai CEO Environmental Protection Technology has at least been able to generate positive FCF in the past.

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 Shanghai CEO Environmental Protection Technology's Profit Performance

As we have made quite clear, we're a bit worried that Shanghai CEO Environmental Protection Technology didn't back up the last year's profit with free cashflow. For this reason, we think that Shanghai CEO Environmental Protection 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. Nonetheless, it's still worth noting that its earnings per share have grown at 24% 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 2 warning signs for Shanghai CEO Environmental Protection Technology (1 is potentially serious!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Shanghai CEO Environmental Protection Technology's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying.

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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.