Zhejiang Zhaolong Interconnect TechnologyLtd's (SZSE:300913) Sluggish Earnings Might Be Just The Beginning Of Its Problems

A lackluster earnings announcement from Zhejiang Zhaolong Interconnect Technology Co.,Ltd. (SZSE:300913) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

Check out our latest analysis for Zhejiang Zhaolong Interconnect TechnologyLtd

Zooming In On Zhejiang Zhaolong Interconnect TechnologyLtd'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Zhejiang Zhaolong Interconnect TechnologyLtd has an accrual ratio of 0.21 for the year to June 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of CN¥67m, in contrast to the aforementioned profit of CN¥109.9m. It's worth noting that Zhejiang Zhaolong Interconnect TechnologyLtd generated positive FCF of CN¥159m a year ago, so at least they've done it in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Zhejiang Zhaolong Interconnect TechnologyLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥9.3m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Zhejiang Zhaolong Interconnect TechnologyLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Zhejiang Zhaolong Interconnect TechnologyLtd's Profit Performance

Zhejiang Zhaolong Interconnect TechnologyLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Zhejiang Zhaolong Interconnect TechnologyLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Zhejiang Zhaolong Interconnect TechnologyLtd as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Zhejiang Zhaolong Interconnect TechnologyLtd, and understanding this should be part of your investment process.

Our examination of Zhejiang Zhaolong Interconnect TechnologyLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with significant insider holdings to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.