Zhejiang Extek Technology's (SZSE:301399) Shareholders Have More To Worry About Than Only Soft Earnings

The subdued market reaction suggests that Zhejiang Extek Technology Co., Ltd.'s (SZSE:301399) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Zhejiang Extek Technology

A Closer Look At Zhejiang Extek Technology's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 September 2024, Zhejiang Extek Technology recorded an accrual ratio of 0.38. 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¥100m, in contrast to the aforementioned profit of CN¥70.0m. We saw that FCF was CN¥44m a year ago though, so Zhejiang Extek Technology 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 Extek Technology.

Our Take On Zhejiang Extek Technology's Profit Performance

As we discussed above, we think Zhejiang Extek Technology's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Zhejiang Extek Technology's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Zhejiang Extek Technology, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 1 warning sign for Zhejiang Extek Technology and you'll want to know about this.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Extek Technology's profit. 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.