There May Be Reason For Hope In Zhongyeda Electric's (SZSE:002441) Disappointing Earnings

Investors were disappointed with the weak earnings posted by Zhongyeda Electric Co., Ltd. (SZSE:002441 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

See our latest analysis for Zhongyeda Electric

Examining Cashflow Against Zhongyeda Electric'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to June 2024, Zhongyeda Electric had an accrual ratio of -0.16. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥711m during the period, dwarfing its reported profit of CN¥168.6m. Zhongyeda Electric shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhongyeda Electric.

Our Take On Zhongyeda Electric's Profit Performance

As we discussed above, Zhongyeda Electric has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Zhongyeda Electric's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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 Zhongyeda Electric at this point in time. Case in point: We've spotted 2 warning signs for Zhongyeda Electric you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Zhongyeda Electric'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.