Changchun Zhiyuan New Energy Equipment's (SZSE:300985) Solid Profits Have Weak Fundamentals

Despite announcing strong earnings, Changchun Zhiyuan New Energy Equipment Co., Ltd's (SZSE:300985) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

Check out our latest analysis for Changchun Zhiyuan New Energy Equipment

Examining Cashflow Against Changchun Zhiyuan New Energy Equipment'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. 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 September 2024, Changchun Zhiyuan New Energy Equipment recorded an accrual ratio of 0.21. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥91.3m, a look at free cash flow indicates it actually burnt through CN¥239m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥239m, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Changchun Zhiyuan New Energy Equipment.

Our Take On Changchun Zhiyuan New Energy Equipment's Profit Performance

Changchun Zhiyuan New Energy Equipment 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 Changchun Zhiyuan New Energy Equipment's true underlying earnings power is actually less than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 5 warning signs for Changchun Zhiyuan New Energy Equipment (3 shouldn't be ignored) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Changchun Zhiyuan New Energy Equipment'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 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.