We Think That There Are Issues Underlying Zhejiang Hongchang Electrical Technology's (SZSE:301008) Earnings

Unsurprisingly, Zhejiang Hongchang Electrical Technology Co., Ltd.'s (SZSE:301008) stock price was strong on the back of its healthy earnings report. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out our latest analysis for Zhejiang Hongchang Electrical Technology

A Closer Look At Zhejiang Hongchang Electrical Technology'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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Zhejiang Hongchang Electrical Technology has an accrual ratio of 0.23 for the year to March 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥77m, in contrast to the aforementioned profit of CN¥92.4m. We also note that Zhejiang Hongchang Electrical Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥77m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Hongchang Electrical Technology.

Our Take On Zhejiang Hongchang Electrical Technology's Profit Performance

Zhejiang Hongchang Electrical Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Zhejiang Hongchang Electrical Technology's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 39% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Zhejiang Hongchang Electrical Technology, you'd also look into what risks it is currently facing. Be aware that Zhejiang Hongchang Electrical Technology is showing 3 warning signs in our investment analysis and 1 of those is significant...

This note has only looked at a single factor that sheds light on the nature of Zhejiang Hongchang Electrical 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.