Zhejiang Hengwei Battery's (SZSE:301222) Profits May Not Reveal Underlying Issues

The market for Zhejiang Hengwei Battery Co., Ltd.'s (SZSE:301222) stock was strong after it released a healthy earnings report last week. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

See our latest analysis for Zhejiang Hengwei Battery

Zooming In On Zhejiang Hengwei Battery'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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, Zhejiang Hengwei Battery recorded an accrual ratio of 0.50. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥23m, in contrast to the aforementioned profit of CN¥130.4m. We saw that FCF was CN¥109m a year ago though, so Zhejiang Hengwei Battery 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 Zhejiang Hengwei Battery.

Our Take On Zhejiang Hengwei Battery's Profit Performance

As we have made quite clear, we're a bit worried that Zhejiang Hengwei Battery didn't back up the last year's profit with free cashflow. For this reason, we think that Zhejiang Hengwei Battery's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that its earnings per share increased slightly 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 Hengwei Battery, you'd also look into what risks it is currently facing. To that end, you should learn about the 2 warning signs we've spotted with Zhejiang Hengwei Battery (including 1 which is a bit unpleasant).

Today we've zoomed in on a single data point to better understand the nature of Zhejiang Hengwei Battery'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.