Solid Earnings May Not Tell The Whole Story For Guangzhou Huayan Precision MachineryLtd (SZSE:301138)

Guangzhou Huayan Precision Machinery Co.,Ltd. (SZSE:301138) just released a solid earnings report, and the stock displayed some strength. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

See our latest analysis for Guangzhou Huayan Precision MachineryLtd

Zooming In On Guangzhou Huayan Precision MachineryLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

For the year to June 2024, Guangzhou Huayan Precision MachineryLtd had an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥48m, in contrast to the aforementioned profit of CN¥76.4m. We saw that FCF was CN¥39m a year ago though, so Guangzhou Huayan Precision MachineryLtd has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangzhou Huayan Precision MachineryLtd.

Our Take On Guangzhou Huayan Precision MachineryLtd's Profit Performance

Guangzhou Huayan Precision MachineryLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Guangzhou Huayan Precision MachineryLtd's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Guangzhou Huayan Precision MachineryLtd has 4 warning signs (2 don't sit too well with us!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Guangzhou Huayan Precision MachineryLtd'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. 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.

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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.