Zhejiang Meishuo Electric TechnologyLtd's (SZSE:301295) Shareholders Have More To Worry About Than Only Soft Earnings

Following the release of a lackluster earnings report from Zhejiang Meishuo Electric Technology Co.,Ltd (SZSE:301295) the stock price made a strong positive move. Our analysis suggests that there are some positive factors lying below the troubling profit numbers which investors are finding comfort in.

View our latest analysis for Zhejiang Meishuo Electric TechnologyLtd

Examining Cashflow Against Zhejiang Meishuo Electric TechnologyLtd'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. 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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Zhejiang Meishuo Electric TechnologyLtd recorded an accrual ratio of 0.22. 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¥45m, in contrast to the aforementioned profit of CN¥32.5m. We saw that FCF was CN¥9.4m a year ago though, so Zhejiang Meishuo Electric TechnologyLtd has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Meishuo Electric TechnologyLtd.

The Impact Of Unusual Items On Profit

Unfortunately (in the short term) Zhejiang Meishuo Electric TechnologyLtd saw its profit reduced by unusual items worth CN¥2.2m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Zhejiang Meishuo Electric TechnologyLtd to produce a higher profit next year, all else being equal.

Our Take On Zhejiang Meishuo Electric TechnologyLtd's Profit Performance

In conclusion, Zhejiang Meishuo Electric TechnologyLtd's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Based on these factors, it's hard to tell if Zhejiang Meishuo Electric TechnologyLtd's profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into Zhejiang Meishuo Electric TechnologyLtd, you'd also look into what risks it is currently facing. For instance, we've identified 5 warning signs for Zhejiang Meishuo Electric TechnologyLtd (3 make us uncomfortable) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.